Now that aptly and crisply sums up what I have been talking about.
The markets will no longer continue to function without pricing in a huge risk premia, and that risk premia will force house prices much lower (due to payment increase).
The real solution to this was to allow wages to start rising quickly.
However, that is a solution that the FED will fight to the death, so now we are in a corner equilibria with a constrained solution set.
Too many houses, too little income to cover higher interest rate mortgages necessary for investors to accept negative convexity.
One other topic that goes with this- lengthening duration throwing sand in the gears of perpetual refis and sales of gse covered MBS bonds.
"The trouble is that convexity involves a whole bunch of seriously geeky math and computer models and normal people probably dont want to go there. (I dont even want to go there.) So as a compromise, this is a very quick and simple explanation of convexity."
Awww, but I like geeky math... But then again, my biggest frustration with my career with an engineer is that I don't get to do enough calculus. Anyhow, it seems that the other way that lenders can encourage repayment of their loans is to aggressively pursue legal judgments against people who default in states that allow them and to try really hard to get those who committed actual fraud prosecuted. In fact, it might make a good deal of sense to do this even in cases where there isn't a good chance of additional economic recovery to increase the risk and headache of choosing to default. Another thing that lenders might want to try is an MPAA like advertising campaign in which they remind people that they are responsible to pay their debts.
One question though - regarding the "default put" - don't most refis have recourse to the borrower?
Another great example of why this shit's so hard to model.
Yes, refis are generally recourse. However, "recourse" really means that if the lender wants to go after you for a deficiency judgment, the lender must choose judicial FC. (Some states, of course, require only judicial FC, like OH. But in states like CA, there is a choice of non-judicial/power-of-sale FC or judicial FC.) So then it becomes a question of which ends up cheaper: winning your deficiency judgment (which you hope the borrower can pay) by spending more on court costs, or just writing it off and going the non-judicial route.
As it happens, loans that are already refis (that are originated as refinance loans) have different prepayment characteristics than purchase-money loans anyway. (All other things being equal, once it refied the more likely it is to refi again if it's in the money. The "efficiency" with which purchase-money borrowers will refi is more uncertain.)
The Trustees of CR University, to whom these presents may come greeting be it known that Tanta, having completed the studies and satisfied the requirements for the degree of Doctor of Mortgage Puts & Calls?, has accordingly been admitted to that degree with all the rights privileges and immunities thereunto appertaining.
Anyhow, it seems that the other way that lenders can encourage repayment of their loans is to aggressively pursue legal judgments against people who default
In essence, I think the problem we're having at the moment is that lenders will never do this until ruthless puts get to be a big problem. They never act "proactively" because, you know, they have to report the expenses of doing that.
Maybe the possibility of "exercise of the put option" is not in the contract but in a non-recourse state, it is implied by the law. I can't find such behavior ruthless.
In the good old days, there was guarantee that it is not worth to default, called downpayment. Just like VIX was incredibly low in 2006 "Goldilocks-economy", the lenders thought the price of this "put option" was minimal and mispriced it.
Tanta, one of the problems is that you are not throwing rocks at the insane mortgage models used by wall street to value the exotics and subprime.
How could anyone seriously buy stuff like that for 101% of face value? Was there no thought of any losses on the part of bond purchasers?
In other words, wall street distorted the entire mortgage market by hatching a bubble that once going, was perpetuated by tranche slicing.
In other words, they built the bubble, and now they complain that it blew up. Make wall street take their losses and now the government needs to step in and correct the market failure that is now becoming obvious.
Bah, this is taking too long to reach bottom, and there seems to be yet another false dawn while we talk about real crisis in the machinery.
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Options Theory doesn't help price fraud. Once you have a totally fraudulent activity, even though it is legally sanctioned, all pricing mechanisms are doomed to failure.
Made a killing of long-term puts on Fraudentials (sold 65% at average of 6X and still holding 35%),
In the good old days, there was guarantee that it is not worth to default, called downpayment.
Exactly. The social purpose of non-recourse laws is not to give ruthless borrowers a put. It is to remind lenders that if they are stupid about LTVs and appraisals, they are giving ruthless borrowers a put.
Of course this behavior is "ruthless." For many people it's quite rational, but default is default. My whole point was that people are looking for reasons to escape the term "ruthless."
I could be way off, but it seems to me the problem cannot be confined (contained?) to the relationship between the borrower and the lender. We are, and have been, to my understanding, talking about bankruptcy of the borrowing party. The lenders will seek judgment and/or criminal fraud actions against those who simply "walk-away". Once that happens, the income and assets of the defaulting party will be attached, and that ain't gonna' be pretty.
"The only situation in which giving the house back to the bank would literally be possible is if you bought the house from the bank (say, it was REO) and the contract explicitly gave you an option to sell it back to the bank, whenever you wanted to, at a price equal to your loan balance. Nobody writes REO sales contracts that way."
Hmmnn. It appears to me that there might be a role for an explicit (rather than the current implicit) put, here. Write the mortgage and embed a non-tradeable put.
I know several fraudsters who are confident that the banks won't pursue them even though they've defaulted (or are about to default) on their loans. I really think that there is a widespread perception that the worst thing that can happen to you in foreclosure is that you have to give up the property.
Hmmnn. It appears to me that there might be a role for an explicit (rather than the current implicit) put, here. Write the mortgage and embed a non-tradeable put.
That has been suggested.
Good luck building a model that lets you price it.
There was a time when some S&Ls basically did write puts on REO sales. Then they blew up and the regulators got pissy about the subject. If you sell REO that way, you carry the liability. I don't think many of these institutions could afford to sell their REO with a repurchase agreement.
Marcus - I think the real issue is that we're NOT talking bankruptcy, we're talking people who can easily afford to make their payments, stay up to date on their credit cards, probably even sock money away in their 401ks. They've just decided that there is a financial benefit to defaulting on their mortgage loans. And the love of their homes, their communities, their children's schools, is no longer enough to outweigh the financial benefit. It's a rootless society that just follows the money.
If I lent money to a risky small business, some part of my payback calculation includes the probability of the business going BK, and this used to be done for individual borrowers as well. The idea that I will lend money at the same rate (or at all) always had to include not only what happens in good times, but in bad. It was "ruthless" competition on the part of the lending conduits which caused them to slash their rates below what their risk equations must have told them would be the consequences in bad times; or to hide those equations altogether. Too much lending capacity, just like to many factories producing buggy whips, and at some point it falls over.
Tanta, one of the problems is that you are not throwing rocks at the insane mortgage models used by wall street to value the exotics and subprime.
You mean I'm not talking about the insanity of pricing credit risk. No, I am just trying for once to talk about something other than credit risk. There have always been and will always be optionality issues with non-exotic prime loans. In fact, the "ruthless" borrower is most likely to have prime credit.
To be honest, there wasn't always all that much wrong with those models. All you have to do is extract the assumption that RE always appreciates, and they work fine.
Nihilist Anarchist Rationalizers. Too bad NAR is already taken.
Shouldn't terms and conditions to mortgage loans be adjusted to remove the convexity? Requiring a down payment and early prepayment penalties obviously skew towards this goal. I guess the only reason convexity and therefor in the money puts were allow to persist was because there was an upstream market that was willing to accept them. My sense is that the solution will come from that side of the business as well. New loan standards will be based upon what can be resold. That leads us to the impending horror of the GSEs preparing to be the repurchaser of last resort.
Thank you Tanta for this most illuminating OberUberNerd Monograph (not to be confused with a monoline).
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"I know several fraudsters who are confident that the banks won't pursue them even though they've defaulted (or are about to default) on their loans."
"fraudsters" know that if they defraud other Fraudsters they are relatively safe.
Kill poison with poison: Let one group of fraudsters kill the bigger group of Fraudsters!
They've just decided that there is a financial benefit to defaulting on their mortgage loans. And the love of their homes, their communities, their children's schools, is no longer enough to outweigh the financial benefit.
And where in the world would they get the idea that their purpose in the world depends primarily on the financial benefit that they generate to society?
The only possible way to get back to an environment in which ruthless default is rare is to abandon the innovations that give rise to them: no-down financing, wish-fulfillment appraisals, underpriced investment property loans, etc.
What surprises me is that the industry is not smart enough to have already abandoned these "innovations" or at least starting pricing them appropriately. Why the industry is originating or why investors are still buying high LTV loans without a huge premium on the yield is beyond me.
It's not that hard to price the implied puts. Any reasonable assumption about home price volatility and underwater buyers defaulting will show a substantial premium for writing the embedded put.
I repeat what I said on a previous thread. There are not enough judges and minions of same to begin thinking of collecting on more than the most minor percentage of hypothetical dificiency judgements. And the banks and lenders continue to cut their personell. If this was to be done, it would need lobbyists in the most hard hit states to start a foreclosure court, with extra high filing fees, said fees to pay for the extra judges, minions, sheriffs, and courtspace. Filing fee in Miami is, umm, a bit more than $250.00. Would the banks pay triple, say, just a guesstimate, to file to pursue a deficiency judgt along with the foreclosure, even to get fast attention? I doubt it.
Their business model is firing people and cutting costs. Pursuit of deficiency judgts might mean everybody else in civil court will have to wait longer. Maybe mean that in Miami, say, you might have to pull judges away from doing divorces and child custody, and probate and mental health work to do dificiency judgts. Frankly, it's not gonna happen. Keeping divorcing spouses from killing each other and keeping kids with the right parents is far more important. Not that the judges do a good job at that, anyway. They are too overworked, and the "system" is underfunded for kids by at least one half.
I guess the only reason convexity and therefor in the money puts were allow to persist was because there was an upstream market that was willing to accept them.
Not necessarily.
One way of looking at is is that the social goal of increasing homeownership was achieved at the cost of convexity problems. Of course you can ask everyone to make a 20% down payment and accept a prepayment penalty. You therefore rapidly decrease the pool of home buyers and sacrifice workforce mobility. You can also make everyone take ARMs whether they want to or not. While there are some convexity issues with ARMs, it's nothing like the curve you see with FRMs. Our expectations are that people can have not just cheap mortgage financing, but fixed rate inflation protection.
Somebody decided we could have it both ways: an "ownership society" and cheap mortgage rates.
Lenders never thought prices would fall this fast when the $ tap was shut off....now the model is broken since refis don't work so good.
As you inferred, people who are made to feel 'ruthless' thru correspondence from the lender when turning in the keys should just repond with the old childlike one-liner: 'Takes one to know one'
Tanta- Canada has reasonable rates of homeownership (somewhat less than the US, but still very respectable) with no fixed-rate mortgages, no zero-down and mortgage interest is NOT tax-deductible.
The lenders going after them for fraud may be exaggerated. Fraud cuts both ways if the lenders were somehow being fraudulent. I'll bet these attorneys drumming up the walk away business are looking for patterns. If lenders initiate actions and facts come out against them, the class action bar will be sitting there salivating. Hell, I wouldn't be surprised to see them goad lenders into the public arena of the courts to gather free "intelligence".
increasing homeownership was achieved at the cost of convexity problems.
Okay, that makes sense.
Of course you can ask everyone to make a 20% down payment and accept a prepayment penalty. You therefore rapidly decrease the pool of home buyers and sacrifice workforce mobility. You can also make everyone take ARMs whether they want to or not.
That would be Australia. Unfortunately they seem to be having many the same troubles as we have.
I am surely happy to have my 4.99% 30yr and Prop 13. While rates are dropping, excuse me, being forced lower now eventually inflation will be unable to be ignored. If the current crop of FB refi to low fixed and then this happens they might be okay but at the expense of banks being even worse off.
Not trying to be hard-headed (we are what we are), but what's to stop this scenario:
Lender sues for performance on the mortgage of the abandoned asset.
Borrower either doesn't show up, or shows up and doesn't have a case.
Court finds in favor of lender and issues judgement against borrower - attaching assets and dunning future income.
Borrower either satisfies judgment or files bankruptcy (if the lender is smart, and if the borrower doesn't show up in court, the court can make it's award non-dischargeable in BK Court).
Either this scenario will play out as described, or theft by fraud has found a legal loophole.
Presumably the currently typical decision not to pursue borrowers in recourse situations for the deficiency is rational, and based on an assessment of the legal and administrative expense of doing so, as opposed to the anticipated recoveries. In other words, why try to get blood from a turnip?
Two probable circumstances are going to compel a reassessment. First, if the problem becomes common, those legal and administrative expenses can be reduced significantly on a per file basis as they are spread over a much larger caseload. Second, more and more of the turnips are going to be worth squeezing. The whole endeavor will start to resemble something like collecting past due child support.
Finally, if the 'ruthless' problem becomes widespread, a certain amount of exemplary justice, per encourager les autres, may prove effective.
These observations are offered without any attempt to address the political fallout from more aggressive recovery efforts.
Shouldn't terms and conditions to mortgage loans be adjusted to remove the convexity? Requiring a down payment and early prepayment penalties obviously skew towards this goal.
You can't remove the convexity. As long as the law requires that pre-payments be legal, you're still going to have that positive slope at the left end of the graph.
Writing from California which still has the 'one form of action' rule*
One thing I noticed a lot -- people would get a mortgage then talk about being just deluged with phone calls, several a day, from the very same mortgage lender -- offering better deals starting immediately. It didn't make sense until I remembered.
One form of action -- the rule only applies to first morgtages.
If you want to block someone from having that legal protection, get them to refinance.
Clever lenders? The big fast mortgage shops must have known they could remove that protection and get access to both the house and the other assets on default, if they could get people to refinance.
And if they knew they were making loans with a high likelihood of eventual default, and the business model was to get at both the houses and the other assets, this would be a tactic.
Til I thought of that, it struck me funny how the mortgage that was "the best available terms" one week was always possible to improve on, and at such low cost, the next week. And why were they so actively phoning their first mortgage customers trying to give away money like that?
Anyone who lives out here knows, the phone would ring several times a day -- any phone, anywhere -- with mortgage calls.
Or maybe I'm too suspicious?
Nah.
In a first mortgage default, the lender has to choose either to take the house, or to go after the borrower's other assets.
The administration is currently pushing for increasing the FHA loan amounts and the FHA maximum LTV up to 100%. This is not likely to remove the incentive to take another reckless loan on a still-too-high-priced house. If we arent going to ration credit with tighter guidelines and loan limits, then it will have to be rationed with pricing: eventually the models will solve the problem by increasing the costs of mortgage credit. You cannot simply keep writing free puts.
This is so well written.
And, then you goto somewhere like quickenloans.com and see all the current ways they try to provide no/low downpayment financing.
A LOT of people still don't get what makes a healthy real estate market.
Ultimately, there is no way anyone can mobilize social acceptability as a defense against the ruthless put (even if you wanted to). The industry has, in fact, created the conditions in which its rational, and as long as its rational it will go on.
Bravo, Encore, Encore. The bankers must reap what they've sown. No Tanta (or her ilk) in the underwriting department means these sorts of problems are going to crop up. Moreover, even if they bring Dr. Tanta back now (at a much high salary than before) its too late to stem the bleeding.
"Like most sociopaths, they dont understand why ruthless would be considered insulting or what this term social acceptability might mean."
Ow! That hurt. Well, ok, maybe not really. Though I think your comment might be more applicable to basic human nature than you think. Attached is a nice workup that basically amounts to answering the question "Why didn't the average Soviet citizen exercise a 'Stalin Put' in 1942?"
People can be darned cold-blooded. In any case, your answer on the embeded put idea is interesting. At first blush, I'd figure modeling an explicit put would be easier than working with the current "Will they, won't they?" environment. If a lender is selling you such a put, they are sending you a signal about their thoughts on the direction of housing. Under the current circumstances, some transparency might be a selling point. I smell opportunity! :^)
"My whole point was that people are looking for reasons to escape the term "ruthless.""
The word does not occur in the contracts, only in your trade jargon. The traditional defense against the default is, as you nicely point out, is in the original structure. You have a premium for the risk or you require skin in the game. (In either case, you do not need to resort to name-calling to be protected). In some circles, skin in the game is reinforced by a kneecap or two in the game. It has always worked.
Thank you for crispness, clarity and at long last convexity.
Someone's comment earlier today invoked a reversal of the usual moral hazard argument (viz, if you keep paying irrational LOs you just get more of 'em) as a defense of jingle mail. I'd say that Spencerian moment, if there's to be one, comes only at the closing.
Lemme see if I get this straight... when an individual does it, it's called "ruthless default," but when a corporation does it, it's called "meeting fiduciary responsibility to shareholders."
Imagine my surprise to discover that financial corporations might be concerned about the social acceptability of individuals doing what the same corporations are regularly lauded by the financial press for doing themselves, i.e. letting bad contracts go to liquidated damages when that turns out to make more financial sense.
Marcus, issuing the judgment and dunning income are two seperate things ... court has no problem issuing the judgment but dunning the income without the debtor being present? Might be the same as making a family homeless ... judges have to run for re-election here ... nobody is going to risk taking the food off the family's table.
What would you consider the possibility that mortgage lending will be further socialized through the GSEs? In my ignorance, I perceive another possibility: somewhat tighter guidelines, somewhat rational loan limits, with the risk downside guaranteed by the gov't to avoid risk re-pricing.
There is/was implied premium in a high FICO score. At some point in the future you can create a simple graph of defaults with FICO scores and negative equity as variables. You can imagine the shape of the curve.
it's my understanding that in civil actions, if the borrower (Defendant) doesn't show up in court, the lender (Plaintiff) will be granted summary judgement (within the law and the jurisdiction of the court to grant such relief). If there is no objection from the opposing party, and the request is within the law, the moving party will get what it asks.
In either case, you do not need to resort to name-calling to be protected
Look, this isn't about name-calling.
You could, I suppose, write a contract that never ever carries any risk to one party. (I don't know why you would, but you could.) In that case, there would never be "default."
Whenever there is any risk to a party in a contract, there is the possibility that the party will try to get out from under that risk by refusing to abide by the terms of the contract. That is called "default."
"Ruthless" is simply the term we use for borrowers who will always seek to maximize their gain, regardless of the rights the contract gives them.
Similarly, "entitled" is the term we use for people who expect to enter into contracts in which they can never lose.
What's funny about all of this is, again, the resistance to the term "ruthless." My view is that people wish to overcome their inhibitions about ruthless economic behavior without having to admit it. They therefore take umbrage over the term.
Did you watch the 60-minutes video? What other non-judgmental term would you use to describe the borrowers interviewed?
""Ruthless" is simply the term we use for borrowers who will always seek to maximize their gain, regardless of the rights the contract gives them."
You mean as opposed to people who seek to minimize their gain? As I said, it is your trade jargon. I don't mean by that to say I approve or not - I would probably never default no matter how far underwater, but... I'd say 'opportunist' or 'defaulter'.
"when an individual does it, it's called "ruthless default," but when a corporation does it, it's called 'meeting fiduciary responsibility to shareholders.'"
No, it's ruthless in both cases. You can use precisely the same sort of analysis to determine when a company is likely to default on its bond obligations, with the only added complexity being the need to take into account asset volatility.
Disagree. In the current environment lenders and servicers are being vilified for the housing "crisis" for just following SOP - foreclosing when the payments stop coming in.
If they were to begin aggressively pursuing deficiency judgments where allowable it would be a public relations nightmare - and would undoubtedly incite legislation to extinguish it as an option.
"when an individual does it, it's called "ruthless default," but when a corporation does it, it's called 'meeting fiduciary responsibility to shareholders.'"
And when a government does it, it's called 'fixing Social Security.'
This is getting Shakespearean. Everyone's a fool, they all serve their own interests, there's much treachery and behind-the-scenes plotting, and everyone dies in the end.
Other than the 'coastal' cities, most areas seem not to have recovered from the 2000 house bubble yet, unlike the US. Plus, the down-payment required in the study is 25% !! Gee, if that type of study was done for the US, no one could 'afford' a home. If that is even remotely close to the average down payment in Canada, then jingle mail generally won't be happening like in the US, as Tanta explained.
You seem to live in one of the bubble markets..worried (yet)?
Well, I suspect that the prices/rates for recourse and non recourse loans are very similar. This would indicate that the "ruthless put" has not been priced in. Only the ruthless, not the insolvent are worth getting a deficiency judgement against.
And I'm probably not the only person to dislike the term "negatively convex." Shouldn't the term be "concave"?
In thinking about contracts I have negotiated, it occurs to me that one would be naive not to negotiate with the understanding that the other party is likely to behave in a ruthless manner if it becomes of significant advantage to them.
Seems to me this all gets back to the idea that if real estate only goes up, then the ruthless/jingle mail case isn't worth worrying about. Oops.
Sorry...if you have a secured loan and the underlying asset drops in value, value is gone. There are two interested parties, the mortgagor and the mortgagee. Why should the borrower assume the lender's loss because the lender was too foolish to demand adequate security or premium?
If I had a mortgage and an earthquake leveled my house, I'd walk. It's not a matter of ruthless, it's simply the deal. It's not an unsecured or personal loan. Bondholders are simply equity investors with a senior claim and receive interest in lieu of excess return and/or capital appreciation. When was the last time you saw an equity investor kick in money to make the bondholder whole? Why should it be any different for the homeowner?
To me, ruthless is the bank sorting clearing checks from high to low in order to maximize NFS fees.
Anonymous-I'm Canadian, but live in the US, in a fairly non-bubble market. The really bubbly markets in Western Canada are dependent on oil (Alberta) and potash (Saskatchewan). What they do will depend largely on commodity prices. Vancouver is the haven for Hong Kong money. Prices have been sky-high there for a very long time. Canadians have a much higher savings rate than Americans and generally expect to save to buy a house. The government also runs a surplus.
Tanta- Can't this be addressed through the tax code? If you walk away, the difference between what you owe and what the bank gets in liquidation is income to you. If you are distressed (job loss, illness, etc.) this can be waived. It could also be waived if you negotiate a modification in good faith. Then the IRS can collect. They are harder to escape than banks.
My father was forced into bankruptcy by his main creditor after two employees embezzled a large sum and vanished. Most of his debt was discharged. Three decades later and after uncounted arguments with new employees at various S&L's and banks he finished paying off the debt he had been forgiven, with interest. He wouldn't have bought this 'put' business or 'Force Majeure' either.
So, are we to understand that Washington thought higher GSE/FHA limits would juice the mortgage market by spreading the credit guarantee blanket wider, but instead it's simply spoiling the whole bunch with bad apples? Doesn't the credit guarantee make up for ruthlessness? I wish you'd do a nerd post further analyzing the conforming limit increase alone.
Oh, and to prove I'm not a complete dummy:
You can't really write a contract with absolutely no risk to one party. The law would not enforce it. It would be a gratuitous promise without consideration. Even if it's executory on one side only--say, you get prepaid for something--you can still lose if you don't perform, or if you find out the value of your performance suddenly tripled since you signed the contract. A contract is both a bargain and a bet, by nature.
One of the characteristics of "ruthless" behavior is that it's much more likely to be socially destructive. When you analyze a contracts case, for instance, you're supposed to ask who future litigants in similar actions would root for. Often, future defendants will be rooting against the defendant in the case at hand--because if they prevail, these future folk will no longer be able to enter into these types of contracts at all.
Try it this way: what discount rate would you use there? How long will it take you to get your money?
Tanta | Homepage | 01.29.08 - 1:04 pm | #
The best way for people to get their head around the difficulty in pricing is by imagining a "Chinese Auction" (sorry if somebody is offended - its what I've always heard them called)...
Imagine two parties each own half of an asset and they want to have a mechanism to buy the other out. They flip a coin and Party A wins. Party A then gets to set the price for the transaction but Party B gets to decide if s/he buys or sells at that price and Party A has to accept Party B's decision. Party A has to price very carefully.
Now imagine that were going on in the mortgage world when you are in front of the lender. Imagine you had to offer loan pricing & terms to the lender and the lender decides to either borrow to you or borrow FROM you at those terms.
Now knowing what we know about early early pre-pay and ruthless borrower risk... how would YOU price the offer knowing somebody else gets to decide which way the deal goes?
I have no idea how I'd price something like that. I wouldn't want to play that game - I'd put my money in a tomato can in the back yard instead unless I could get a lot higher price than is currently the norm. But I'd probably not want to borrow at the price I'd want to lend at either.
That's what the credit market is saying right now regarding the proposals to add big chunks of jumbo to their previous creamy smooth GSE conforming soup. No thanks - I'll eat at home.
Why should the borrower assume the lender's loss because the lender was too foolish to demand adequate security or premium?
I'm not sure what, exactly, you think we're disagreeing about.
My own view is that very many, but not all, people will default if you put them in a situation in which the consequences of default are more to their advantage than not. That's why I have always been into down payments and good appraisals and all that other old-fashioned stuff. You don't enter into contracts with terms that are unfavorable to you.
There are, however, some people who understand a promissory note to be a promise that has to be kept, even if it becomes unprofitable. If you're willing to call these people "rubes" or "patsies" or "suckers," then I think you should be willing to call defaulters "ruthless."
This subject always reminds me of a hundred years ago when I was a salesclerk in a fairly upscale department store. Dealing with the return policy headache. If you take back too many ball gowns that were worn once (and cannot be resold at the price you just refunded), you'll have to do something about your prices to everyone. That's just the way it works. Otherwise you enforce more restrictive return policies that piss off people whose returns are legitimate.
I can't believe I grew up, left retail, and got into mortgages. Must be bad karma.
Lemme see if I get this straight... when an individual does it, it's called "ruthless default," but when a corporation does it, it's called "meeting fiduciary responsibility to shareholders."
Then...
Allen C
ruthless - having no pity; cruel
Sorry...if you have a secured loan and the underlying asset drops in value, value is gone. There are two interested parties, the mortgagor and the mortgagee. Why should the borrower assume the lender's loss because the lender was too foolish to demand adequate security or premium?
Can't this be addressed through the tax code? If you walk away, the difference between what you owe and what the bank gets in liquidation is income to you.
Well, yeah, but we just changed the tax code precisely in the opposite way.
I agree that there isn't the capacity or will to do a lot of criminal prosecution.
However, you could have some 'poster child' examples. Especially if they went after someone that fit the 'ruthless' criteria precisely. That is, someone that is sending the keys back on an expensive property and has enough income and assets that make them nowhere near hardship.
I don't know if it will be done, but it would be smart for the lenders to find some poster child examples the sooner the better.
I can't take credit for this, but it perfectly illustrates the hypocrisy of banksters accusing FBs who walk away of "unethical" behavior:
First to walk were the federal regulators.
Then the mortgage broker walked (after taking his commission).
Then the lender walked (after selling the loan).
Then the mortgage securitizer walked (after selling to pension/hedge fund).
Then the ratings agencies walked.
Last to walk was the borrower.
"If I had a mortgage and an earthquake leveled my house, I'd walk. It's not a matter of ruthless, it's simply the deal."
I don't think that's quite it. Keep in mind that you are not buying the house from the lender, nor is the lender buying the house and then letting you use it for a fee. You buy the house with money the lender gives you; the lender merely states as a condition that he gets dibs on the proceeds if you find yourself forced to sell. Your obligation was not conditioned on whether the house burns down, falls due to earthquake or termites or stands for a thousand years.
That said, I see nothing perjorative about saying that you'd ruthlessly protect and maximize your own value under the circumstances. Your counter-party (in fact, all potential parties) would do the same. That's the nature of an arm's-length transaction.
More practically, though, you do suffer the temporary cost of more limited access to further credit and/or greater difficulty in getting a job that works with large quantities of money. But this too shall pass....
So, are we to understand that Washington thought higher GSE/FHA limits would juice the mortgage market by spreading the credit guarantee blanket wider
You give them too much credit, in my view.
As far as I can see, they're just trying to reflate house prices. That makes the ruthless borrower go away because default is no longer the best option.
In any event, these proposals are not dispersing risk, they're concentrating it. The private investors and portfolio lenders folded, and now we want the GSEs and FHA to be lender of last resort.
... Party A then gets to set the price for the transaction but Party B gets to decide if s/he buys or sells at that price and Party A has to accept Party B's decision. Party A has to price very carefully.
My parents would let one kid cut the candy bar and let the other choose. The presumption is however that both sides want the same thing.
Marvelous post; exceptional writing. What you call "ruthless," the law-and-economics law schools (Yale, Chicago, Virginia) call an "efficient breach." If it's any comfort, plenty of my classmates balked at such efficiencies when confronted with a now-unfavorable contract. I'm certainly curious to see just how many people are ruthless, er, efficient, in real life.
That said, I see nothing perjorative about saying that you'd ruthlessly protect and maximize your own value under the circumstances. Your counter-party (in fact, all potential parties) would do the same. That's the nature of an arm's-length transaction.
Xactly. In a rapidly rising market, would the lenders hesitate one second to foeclose on a down-on-his-luck borrower that was behind on his payments, just because that would be the "ethical" thing to do? A: Hell no.
Ruthless = rationally protecting one's own in a ruthless (and rigged) game.
Covering this via the tax code is the wrong approach - that just brings in another (disinterested) third party. Its a pricing & terms issue. The market needs to price in the options risk better or offer term conditions that protect lenders from this risk (i.e. demand more down payment). In effect telling the borrowers to send us the keys if you want... we got a 20% head start on any loan losses.
"some people who understand a promissory note to be a promise that has to be kept"
If it's a personal loan or unsecured then yes I concur.
If it's a secured, non-recourse note with a formal lien on the underlying asset, then no.
The dress buyer in your story committed low level fraud. The homeowner (equity holder) is walking away because the value is gone leaving the lender (bondholder) with the remainder. If it's secured, non-recourse, it's the deal.
When the banksters and so-called "regulators" start modeling "ethical" behavior as a matter of course, I'll change my tune. Until then... it's just chickens coming home to roost.
Technically, the loans in a GSE portfolio are not "federally backed", and the GSEs are not "too big to fail". However, the bond market prices them and acts as though they were.
IANAL, but on a practical level, this (substituting the current value of your home for the current balance of your mortgage) seems to be the deal.
I think that "ruthless" has a connotation of violence that implies that the borrowers are kind of aggressive predators, and that is what pulls peoples' (mine included) chains. These situations have been fostered by a deliberate and fundamental aggressive activity by investor groups and lenders to foster the housing bubble, slash risk management, and commodify living arrangements under terms that were of short term profit to their owners and there is no way that you can say that on a social level that the individual "poster children" had equal power in the relationship. The fact is, people in earlier generations not only had moral imperatives holding their feet to the fire to honor their obligations, they were more often than not more deeply embedded into a lively community of support, the very communities which have been dissolved by the aggressive actions of the lenders and financial "free" markets.
The behaviour of the 60 minutes couple can be neutrally described as "selfish", certainly, but there is only one side of this story which was so tightly organized to be "ruthless", I'd say.
Anyone who thinks jingle mail is "part of the deal" with a mortgage will find out otherwise as soon as he tries to get another one.
He will then discover that the lender will charge him a much higher interest rate than he used to pay. He will ask why that is, and the lender will say it's because his credit report shows that he is a defaulter.
As someone else has already noted, the trouble in the boom was that we thought FICO offset down payment. FICO, of course, is supposed to measure your willingness not to default on debts.
If you mean as a matter of law (or fact), you are simply incorrect.
There's the promissory note, in which the borrower (debtor) promises to repay the loan with interest. Then there's a separate mortgage (or deed of trust) executed by the borrower/debtor, which grants the lender an interest in the real estate and also contains a promise to repay the loan in accordance with the terms of the promissory note.
The mortgage is a security for the Note, it is not a substitute for the Note, which is exactly why it reaffirms the terms of the Note.
If that is true, then potentially millions of former FBs will become renters for life. And that will mean far more inventory to choose from at lower prices for people -- like me-- who refused to participate in this massive Ponzi scheme.
In a rapidly rising market, would the lenders hesitate one second to foeclose on a down-on-his-luck borrower that was behind on his payments, just because that would be the "ethical" thing to do? A: Hell no.
But it's quite rare to foreclose on the distressed borrower in a rapidly rising market. The distressed borrower can sell.
Either way, the lender just gets paid back. The sale proceeds over and above the amount of the debt belong to the borrower.
If we wrote shared-appreciation loans, now, that'd be different.
Tanta writes:
Anyone who thinks jingle mail is "part of the deal" with a mortgage will find out otherwise as soon as he tries to get another one.
On a purely contractural basis, I have no problem with jingle mail. After all, business is business. What should prevent it happening is some adverse outcome - like destroying your credit risk.
"No, it isn't the deal. We would not call it "default" if it were the deal."
I most respectfully disagree.
If a corporation defaults on a secured, non-recourse loan, the lender exercises their senior claim on the asset(s). If the deal is secured, non-recourse, the lender has no right of further claim. That's the deal. No?
Read the column on government sanctioned re-writing of mortgage responsibilities. In Congress they call it a "tweak." It's a disaster. And thanks to all for avoiding the phrase, "Someday this war is going to end." Ooops.
But Tanta, with the demise of the FICO system now becoming readily apparent, shouldn't a lender attempt to renegotiate the terms to avoid the yawning chasm of cascading cross defaults implied in the race to the bottom that is developing.
More jingle mail means more REO, REO further actively depresses the market, leading to more jingle mail and more REO.
The problem is the disassociation of the end lender into ten tranches with different owners represented by some anonymous chicago trust that uses XYZ loan servicer.
Say my house is now worth 20% under what I owe- would it be in the lenders interest to modify the loan to pay a much lower rate of interest on the loan to forgo the potential losses associated with REO?
I would think so, but the phone call from the primary lender has come in yet suggesting a mod that would make economic sense.
In fighting the term "ruthless" and trying to substitute something else really implies criticism of the Chicago School of Rational Expectations. Fighting that in today's world is a losing battle. Did you know that research shows teaching undergraduates about rational expectations specifically strips out morality? Check out the literature regarding exposure to rational modeling and the outcomes from prisoner's dilemma in undergraduates.
We have encouraged folks to become sharks, so evincing surprise when they actually begin to follow the models should not be allowd.
Gary Becker is howling with laughter right now at this foolishness.
These are not corporate loans. Price Stout is correct. The legal documents creating a residential mortgage loan do not make price of the payoff equal to the current value of the property. I don't know how many times I have to say this. You can, if you want, say that the terms of the mortgage loan can be described in options language. That does not mean that these are options contracts.
It means lenders mispriced the risk of no-down lending.
Clue me this.
A mortgage contract is not written as an explict "put" option, but isn't the risk spread premium suppose to account for that. If the load was 100% recourse (and collectable), shouldn't the interest rate be equivalent to the conforming rate?
As an aside, exhibit 2 was a great inclusion. A way to enhance it, to my mind, would be to plot the difference between the 10-year and the MBS as a single graph as a follow-up. It would, of course, look very much like the payoff diagram of an explicit equity put, which I think brings the point home.
Don't the GSEs & FHA make loans to people with foreclosures, once they've passed the 2-year mark?
Only with documented extenuating circumstances. In other words, only if it's "distress" instead of "put."
To that I say: Congress can --and, when sufficiently pressured, will-- change the rules of the game any time they see fit. There could potentially be millions of people walking way --regardless of whether it's a "distress" walk, or a "ruthless" walk.
How does the old saying go? If you're going to do something stupid, do it in large numbers.
shouldn't a lender attempt to renegotiate the terms
Well, I've been arguing for the sense in workouts all year. Often to the howls of outrage of the "moral hazard" brigade, who have been telling me at length that a deal's a deal: you agreed to pay this much and you have to pay it.
On the whole, some of this (say, the hesitant-ruthless borrower) could be solved with lenders just getting over it and cramming themselves down.
Some of it can't be. I don't know if you've ever tried to negotiate with a truly ruthless borrower, but my experience is there's no point to it.
"Some of it can't be. I don't know if you've ever tried to negotiate with a truly ruthless borrower, but my experience is there's no point to it."
Well, there is some value in not defaulting, even if you come out ahead vis-a-vis your current mortgage. Restricted access to credit going forward isn't cost-free, unless you're moving into a cave without electricity and becoming a subsistence farmer.
Alright, call me old-fashioned but I never paid much attention to the price of my house either during the boom or now during the bust. I bought a house I like and can COMFORTABLY AFFORD. It is not an ATM nor is it an investment-that is what I have stocks, bonds, CDs and a small business for. It's just my house, which I intend to continue living in unless dire circumstances (fire, flood, grave illness. etc.) force me out. If I wanted to invest in RE, which I don't, I would buy an apartment or commercial building.
I agree, but secured, non-recourse is secured, non-recourse. If I promise to pay regardless, then it seems beyond non-recourse. I must be missing something here. TIA.
The ruthless/dumb couple on 60 minutes were especially upset with the fact that they couldn't refinance but were stuck both upside down and with an 11% interest rate.
Being down $100k @ 6 percent, tax deductible is like an extra car payment.
They were 'dumb ruthless' -- not exactly a position I would like to find myself in.
Anyway, I still think most people with problems will be stressed or distressed -- not the cool, rational smart money that walks without any blowback. Like Donald Trump.
If the load was 100% recourse (and collectable), shouldn't the interest rate be equivalent to the conforming rate?
As long as you factor in the costs of collection.
There is the time value of money. That's actually why conforming GSE pools have some additional value to investors: the GSEs don't just guarantee "eventual" return of principal, they guarantee "timely" repayment of principal. The GSE (or servicer) advances principal to the investor, and then goes and collects it from the borrower. So if you own part of a GSE MBS, you don't have to account for it taking a year to get your hands on your principal in a default situation.
So yes, the GSEs have the pricing problem of setting the guarantee fee. But there's still the "call" issue with conforming vs. jumbo.
Tanta sayeth: Well, I've been arguing for the sense in workouts all year. Often to the howls of outrage of the "moral hazard" brigade, who have been telling me at length that a deal's a deal: you agreed to pay this much and you have to pay it.
This member doesn't see it that way. I've been arguing that a public willingness to do workouts will "create its own weather" and thus expand the pool of candidates for workouts. The hazard isn't in letting some FB "get away" with something. The hazard is to the system that becomes a larger problem by becoming an attractive nuisance.
I have agreed with you as the declines have accelerated that the need for mods is apparent. What is happening is the very disintermediated structure is putting the asset owners at cross purposes and not allowing even hesitant-ruthless borrowers (a class that I probably fit into) a chance to even begin to negotiate.
I think we will see outright capitulation by the mortgage first lienholder brigades with the heloc folks fighting a rear guard action that only delays the inevitable.
Meanwhile, a lot of folks that might have just held their noses and continued to make their payments are going to walk because they feel housepoor, and they see a large number of empty houses just sitting on the market in thier area with no progress in clearing the overhang.
That leads to the race to the bottom.
What reasonable thing can you tell an ARM holder facing reset that is now 15% underwater? Too bad, go away?
The sad part is that this bubble, unlike the last stock bubble, took in a whole bunch of folks that would have most likely in the next few years made it as homeowners and allowed the boomers some support to their fantasy of selling the old homestead and using the money for a trip to Bali.
Now, no dice.
I think a lot of the moral brigades understands that this will impact them as the real estate market will most likely not have another bubble in their lifetimes. That realization that real estate is over will be quite painfull in the coming decade, and will make an already angry polity even more grouchy.
As far as I can see, they're just trying to reflate house prices.
To fix things, they don't need to merely reflate current prices in some way. They need to reflate appreciation rates, too, back up to bubble levels. The promise of future appreciation was the only thing supporting current prices.
I think if the villagers recognized that, even they would choke on it.
Tanta,
I'm going to send this post out to everyone I know (including analysts working both here in the U.S. and in India) who is working on their CFA. You summed up in about 10 pages what it takes Fibozzi's "Fixed Income Handbook" about 150 pages to do, and in a much more clear and understandable way. BRAVO
I'm suspicious about the numbers for Vancouver, since they somehow come up with a median house value of $503,400, while the
Greater Vancouver Real Estate Board states that the value of a "detached" house is $732,320.
I couldn't find anywhere how the first study defined what a house is, but in Vancouver a house is detached, while an attached unit is a townhouse, and an apartment is a condominium.
"I think a lot of the moral brigades understands that this will impact them as the real estate market will most likely not have another bubble in their lifetimes. That realization that real estate is over will be quite painfull in the coming decade, and will make an already angry polity even more grouchy."
I am not sure what it would take to put a stake through the heart of the real estate investment thesis. I think most people would still say that housing will cost more in 5 years. Excluding ground zero in the current bubble. Not above the maximum prices but current prices.
Ding! Ding!
Award to lessismore for being the first to say "efficient breach."
And Tanta is correct, bytheway, it IS a breach. Thus damage to future creditworthiness. But we don't drag people out behind the barn and shoot them for breaching a contract. Well, not so much anymore. Dirty rotten contract-breachers. Instead, we just gather what apples we may, based on the safety mechanisms built into the contract. Some lenders are learning that some borrowers price the results of breach differently than others.
Your house is a consumer purchase not an investment. If you can afford it and you enjoy its use, then by all means, go ahead. If you want to invest for the future (as you should) than you need to acquire a share in what Marx called "the means of production". That can be stocks, investment real estate (i.e., cash-flow generating property), a business or anything that generates future cash flow.
The fact that so many misunderstood that is the root of the problem.
Rob, we are going to take our pain one way or another, so why not allow folks to keep their palace at a cheaper rate. One of the things I advocate for is simply cutting the interest rates waaay down. Then when the real estate market finally comes back the priciple will at least have a chance of being repaid.
These losses to principle through crappy recovery rates are far more devastating in terms of valuing pools than a lower interest rate would be.
That is how you deal with stranded borrowers, not by saying "Oh well, if we give you a deal, then everyone will want it."
Do the deal, and give them cheap interest rates, without changing the structure of the current loan in terms of refi's. Just do the mod and take less interest. Ruthless folks will prepay their mortgages, or they will just pay less and keep spending.
Either way we get what we need, a big slowdown in foreclosures and some economic stability.
The current course is madness, and will lead to a Js Jin paradise.
Rob, sometimes you just have to accept that the ruthless folks get out and win under the cover of the common man's disaster.
Casey showed that playing the game was darned near riskless in living well for a couple of years on OPM.
You summed up in about 10 pages what it takes Fibozzi's "Fixed Income Handbook" about 150 pages to do, and in a much more clear and understandable way
My new motto: "I read Fibrozzi so you don't have to."
Actually, I didn't learn about mortgage pricing by reading Fibrozzi (useful as his text is, no question).
I learned about mortgage pricing after having been removed from my comfortable cubicle in credit policy and being escorted to my new cubicle in secondary marketing. As my boss said at the time, "Don't be intimidated. Your new colleagues have better math skills than you do, but since you're the only one in the room who actually knows what these "mortgage" thingies are we're trading, you have a distinct advantage."
Personally, I don't think people will give two shits whether or not you call this "ruthless", "fascist", or whatever for walking on underwater loans. This is the natural course of events when you get away from solid lending practice.
The banks and Republican ideology is at fault here. The banks and their people are largely at fault because of their ruthless pursuit of percentage. Bush and his minions (think Greenspan and Ayn Rand) took the controls off because that's exactly what they wanted to do. They wanted an economy where control was light to nonexistent, and this is the natural result of all that.
Over the past several years I've become very conservative about finances. I do feel that, if we went back to an educational system that stressed traditional classical education, people might have a more strategic view of these things, instead of the totally operational society we live in now.
I don't have a problem with the word "ruthless". Hell, I'm willing to bet that some traders on Wall Street would be honored if you called them ruthless .
Instead of calling a person ruthless, I'd just say she is marking her house ( and mortgage ) to market. If the MTM of this portfolio is negative and she has a legal option to exit at zero then that sounds financially rational to me. It might be immoral, but it's hard to argue that it isn't rational.
The one thing people probably don't factor in is the cost going forward. Good luck when she tries to find cheap credit in the future.
It seems to me that the real problem here is a total pricing failure on the part of lenders. They priced the rates on their loans using irrational assumptions about the market. My friends in finance have many colourful phrases for this situation -- "quote the wrong price often enough and eventually someone will rip your face off". lol
my first comment here to congratulate Tanta on another truly outstanding post! thank you.
Whether termed ruthless or efficient breach, we are talking about breach of a contract which was based on both consideration and mutual assent. Accusing mortgage "sellers" of malfeasance ignores that in many cases the buyers were just as greedy. Not just greedy, but also savvy enough to understand concepts like "cash out", now "upside down" and "putting" (but not "ARM"?). IMHO, nevermind what they're selling, its what you're buying.
A key finding from the report that everyone should recognize:
Low affordability is driven by restrictions on building, not low interest rates or population growth. Many markets that grew very rapidly in population (Houston, Dallas, Ottawa) remained affordable.
I wonder what Uncle Sam would think of all this. Wouldn't the ruthless borrower owe the IRS for his ruthlessly taken forgiven loan? Would the IRS pursue payment eventually even tho lender would not?
AllenM writes:
Rob, we are going to take our pain one way or another, so why not allow folks to keep their palace at a cheaper rate.
You mean my palace. Seriously, it isn't theirs and never was and now never will be. We cannot choose to reverse discriminate on the basis of financial acumen lest we become Harrison Bergerons and all devolve to the lowest common denominator.
THE YEAR WAS 2081, and everybody was finally equal. They werent only equal before God and the law. They were equal every which way. Nobody was smarter than anybody else. Nobody was better looking than anybody else. Nobody was stronger or quicker than anybody else. All this equality was due to the 211th, 212th, and 213th Amendments to the Constitution, and to the unceasing vigilance of agents of the United States Handicapper General.
While we're on the subject of workouts, here, let me note that this is why I opined a few weeks ago that you can't get very far trying to do a short sale with a truly ruthless borrower.
If the borrower truly doesn't care what your loss is, the borrower will try to sell the house for $10 to his brother-in-law Verne without a real estate broker to "eat fees."
That's why, whenever you as a servicer are presented with a short sale proposal, you have to slog through the process of verifying that it was an arm's-length deal and the sales price is the best the market will bear. Otherwise all you're doing is making the put that much cheaper.
Anonymous-I have been to all of those states. I suggest you READ the report. Affordable housing can be built anywhere. The reason it is not is that existing homeowneres don't want "those people' living near them so they enact minimum lot sizes, restrictions on sub-dividing and on and on. No place in the US grew faster than Texas in the 80s and yet Houston and Dallas are 2 of the most affordable cities anywhere. Even New York is considerably more affordable than LA, SF or San Diego. Now why do you think that is? Think high rises vs endless tracts of single-family houses.
Marcus I don't do collections but imo with respect to the judges I practice before they aren't going to let you garnish wages unless you provide them with sufficient facts for them to conclude it won't be detrimental to the deadbeat's dependents. A judgment is no problem but actually leaving a family with no funds? All it takes is one ugly case to hit the papers and the judge is in a world of hurt ... no upside whatsoever for him to grant the requested relief ... generally here in florida you don't sue at all unless there is an insurance company that can pay the damages (unless you are going after really deep pockets) ... never heard of a personal injury lawyer turning down policy limit ... I see this a lot in probate cases where MBNA got a judgment against the deceased, they never actually try to collect the judgment through court action cause no judge in the world is going to garnish a little old lady.
One easy way of seeing that even a non-recourse mortgage is not a put option is looking on the credit report. Excersing puts doesn't leave black marks on the credit report, foreclosures and short sales do.
I didn't say the financing had nothing to do with it. It was necessary to enable prices to get so high. Nevertheless, financing was not sufficient. Land restrictions were essential. Car companies have 0% financing all the time, yet car prices don't go up to the sky. Why? Because they build as many cars as people want to buy.
Anyone who thinks jingle mail is "part of the deal" with a mortgage will find out otherwise as soon as he tries to get another one.
For a while, perhaps. But the thing about ruthless self-interested people is that they're very predictable and easy to deal with. Write the contract so it's in their interest to keep following it. And that's very easy with mortgages - 20% down and stay away from bubble markets. If the banks haven't figured this out in a few years I see a great business opportunity. And for the next few years if they're prevented from buying it will be to their benefit.
The Fibbonacci numbers are smaller than the number of Fibbonaccis on this plate. Let us therefore start eating. "Lord thank you for this mortgage pig, we shall not draw your pig in vein and we shall not make Fibbonaccis out of him or his family without prior blessing. The fibbonaccis shall be contained (in a container)".
"Markel writes: Jingle mail is not an efficient breach of contract. In an "efficient breach," you have to make whole the party to whom you broke your promise...."
I was wondering if someone was going to make that argument. Generally, your statement is correct, but I wonder if the fact that the lender appraised the property BEFORE making the loan affects the analysis. In other words, the lender did not simply review the buyer's financials and FICO in order to assess the risk of default, but also evaluated the property itself to ensure that the loan was adequately secured. That seems to shift some of the risk of lower property values to the lender, or at a minimum, the lender recognizes its exposure to the risk of default when the LTV is greater than 100%. Otherwise, why would the lender bother with the appraisal in the first place?
That strikes me as significant. Both the borrower and the lender are making an informed bet (based on property appraisals) that the property value will not drop below the loan value. If the lender has a gripe, it probably should be with its appraiser. But the news is replete with appraisers claiming that the lenders encouraged high appraisals in order to make loans. All of which makes me think that the lender did get paid for the implied "put" option - the fees it received for making the loan. Unfortunately for the lender, it simply undervalued the risk of default viz. those fees, and instead should have charged more fees or higher interest.
aotc,
I notice sizzling Scranton is also quite affordable, in spite of suffering from that Northern affliction of zoning.
I also note that the study seems to avoid macroeconomic explanations for any housing affordability issues.
Zoning in the USA is not the story behind rising house prices.
Further, I note that many of the places that have implicit affordability have extremely high property taxes due to declining macroeconomic conditions.
Um, same sized house in similar neighborhoods in Phoenix and Dallas yields a difference of 50% cheaper property taxes in Phoenix, even for a house priced at twice the price in Dallas.
The problem is that if a house is worth X dollars, but the property tax is twice what house Y is worth, that differential in property taxes is reflected in the price.
Property taxes are a huge drag on property prices, and Prop 13 illusions of affordability are part of the problem, not the solution. Geez, Rob do some 'splaining 'bout mello roos..
All of which makes me think that the lender did get paid for the implied "put" option - the fees it received for making the loan.
You're absolutely right, and that is in fact my point about why non-recourse laws exist. Their purpose is (supposed to be) to force lenders to get real with those appraisals and down payment requirements in the first place. They just didn't have the correct inhibiting effect because investors drank the koolaid about endless appreciation.
About the pricing, the lender might have gotten paid for the loan, but the investor didn't get paid for that "put." Or, to be more precise, did not require to be paid for that put. In other words, investors did not adjust their options analysis model to take into account the fact that a historically unprecedented lending practice (no down based solely on a FICO) would create "puts" where there did not used to be "puts."
"The premium is supposed to go to the writer of the put."
It's a non-cash premium.
Tanta,
Can you help me out regarding this moral/ruthless/deal topic?
Price Stout's post was interesting. What is the typical homeowner signing? If the law prevents recourse, but the homeowner promises to pay regardless, what does that mean?
Is the CFO that walks ruthless, efficient, or something else. Perhaps I'm attempting to draw a parallel that shouldn't be drawn?
One of my degrees is in finance and I scored highest on the CFA ethics section. This has to be a difficult dilemma for the average homeowner facing foreclosure.
they aren't going to let you garnish wages unless you provide them with sufficient facts for them to conclude it won't be detrimental to the deadbeat's dependents.
Yep and the precentage of income the lender gets in garnishment is actually quite low on mere unsecured debts (in my state anyway YMMV).
Not to mention the time and process of hiring a local attorney, serving the debtor and actually getting into court since they are so clogged with criminal cases anyway and those get priority - lenders trying to get before a judge may have a long wait ahead of them on a deteriorating property on which they may be liable for property tax.
Tanta- Sorry....not much else happening today I suppose.
Just think, if the # sign was actually a direct voice link to the poster, that could really shorten some of these threads by taking 'heated' posts off-line
It's a non-cash premium being paid to somebody other than the writer of the put. What am I, the original lender, supposed to do with your new credit report problem? Feel vindicated? That's not a option fee.
You pay a put premium when you buy the put, not when you exercise it. If you don't exercise it, you don't get the fee back. Right?
Look, all "recourse" means is that the lender (may) have recourse to other assets of yours besides the house in some cases of default.
But of course lenders don't want to go to court to get at your jetski. They don't want to own your home, either.
Maybe it will help you to remember that mortgage pricing is about valuing a cash flow. If we have to start pricing mortgages assuming that we get a non-negligible amount of our principal back by long expensive legal recovery means, then we will do that. That means mortgage rates/fees will go up.
And they will go up for everyone, because you cannot by definition "find" a ruthless borrower in any pool that allows no-down offset by a high FICO.
Or, we can eliminate no-down and demand realistic appraisals. That will fix the ruthless borrower problem because that means the borrower has "skin in the game."
What we will not do is continue to offer no-down financing at the same cheap rates. Because they result in too many "puts."
I assure you I am not a troll. Remember it was Alpha_Bear who found this report, not I. I apologize for getting annoyed, though.
Allen- There certainly are places like Scranton or Buffalo that have experienced such population loss that it is virtually impossible for prices to have risen. Nevertheless, some places with little population growth (Boston) have had huge price rises and others with very rapid growth (Dallas, Houston, Charlotte) have remained affordable. Why is that?
You are correct that taxes are a component of housing costs. Nevertheless, I submit to you that if you included property taxes, the relative standings of these cities would not change much. LA, SF and SD would still be enormously unaffordable, despite their not having grown all that rapidly in recent years.
I'm not letting the banks off the hook. But we all have some blame. If your neighbour decided to create affordable housing by renting out rooms or allowing 3 houses to be built on their lot, would you be at the next city council meeting complaining? I suspect many of us would at least be thinking about it.
HARM writes: (01.29.08 - 2:06 pm)
When the banksters and so-called "regulators" start modeling "ethical" behavior as a matter of course, I'll change my tune.
I am sure the modelers have estimates of the "ethicality" of the borrowers (what Tanta would term "lack-of-ruthlessness") in their models. Much of the hand-wringing right now is due to the (completely unforseeable!) fact that their estimates, when applied to average Americans, were either way off-the-mark, or have changed dramatically.
Much of the hand-wringing right now is due to the (completely unforseeable!) fact that their estimates, when applied to average Americans, were either way off-the-mark, or have changed dramatically
It is, ultimately, about failing to account for moral hazard. We "over-insured" these folks and they are acting exactly the way theory predicts they would.
Houston and Dallas in the 80's experienced a tremendous crash in real estate that overshadowed the market there for at least a decade, if not realistically until today. That was an income crash for an entire region- LA has not had a significant income crash since the last housing crisis in the early 90s, and still has a significant advantage in earnings for the entire areas.
Denver is another market that did not experience the huge run up in pricing that the coast did.
I am not arguing that there are not valid reasons why there are huge pricing differentials, but that article mainly is about pricing versus income. Places with significantly higher property taxes versus places with lower taxes but with similar incomes will show the differential most markedly. Texas is well studied in the economic literature with regard to the housing pricing differential due to the lack of income taxes. By putting the incidence of the tax onto the property owners, lower real estate prices have resulted in the choice of the tax structure and the choice of wealth accumulation.
Building more houses is not the solution when you have had a housing bust, and removing zoning to allow renting out McMansions as apartments will not help out the owners of neighboring properties. If anything, the history of the relaxation of housing into lower class transient housing in the urban east should demonstrate to you that zoning has value. Ever seen an entire row of what had been mansions in the 1890s-1920s turned into cheeseball apartments? It exists back east in spades.
The problem wouldn't be solved by building more housing that is more affordable- they just did that in California, and I note that the new affordable housing is where the property crisis is concentrated.
Lack of earnings to support the prices is the issue, not zoning restrictions in Newport Beach.
Sorry to preach, but sometimes the Cato Institute stuff really bugs the crap outta me.
"I am sure the modelers have estimates of the "ethicality" of the borrowers (what Tanta would term "lack-of-ruthlessness") in their models."
Not precisely. You can't know what lurks in the heart of man, after all. As far as consumer default-risk models go, though, they routinely capture "stability" attributes like time-at-residence and time-at-employment, etc. These aren't markers for ethics, though, they're more indicators of "skin in the game" with regards to tenure, neighborhood/local links, etc. In other words, they indicate that the borrower does not intend to fly-by-night at the first whiff of trouble.
Tanta,
Enjoyed the post, excellent work. What it seems you are saying is threefold. first, there is no put option in a mortgage contract, therefore, anyone that "puts" the asset back to the mortgagor is acting immorally and third, if ever a put were to be included in a mortgage contract it would be impossible to price.
On the moral issue, I have the answer. Ayn Rand apparently says that there is no collective responsibility, that it is moral that individuals act always in their own self interest. Also, capitalism is the only "morally correct" system. On this basis, walking away is a moral thing to do, isn't it? If the basis of the idea that "what's good for business is good for America" is that business gets a free pass on moral issues and if we add Rand's philosophy that Capitalism is by its nature morally good, then nothing that either the banks or the individual lender does can be construed as immoral, can it? I suppose I mean that what's "morally acceptable" for the upper classes is eventually morally acceptable for everyone is an age old truism that has bitten us on the ass time and again throughout history.
Now onto the banks/hedgies etc. I fully believe that there is no explicit put option in mortgage contracts and that there is an explicit call option (I checked my own 15 yr mortgage on a house upstate). The problem is that the mortgagors are also acting in a sociopath manner to avoid their responsibilities. They set up a financing model whereby profits were generated by fees and they then used a plainly bogus set of information to pass on the risk of the mortgages they wrote. They have as a group, both in morgage financing and in consumer credit generally, acted to purposely target the most vulnerable by structuring contracts that were impossible to hoinor to maturity and then overlaid fees, penalties etc to generate a return to the extent that, even when a debtor eventually defaulted, they would offer another card/mortgage/line of credit almost immediately after default to begin the merry-go-round again.
Now these banks have created a culture of default without obvious penalty and now it is time to pay the piper. But again, these financiers are acting ina truly Randian fashion, by refusing to acknowledge the extortionate relationship they have with both investors and customers and insisting that the taxpayer take on the cost of their own actions over a number of decades.
I think the idea that any system must be assumed to be "moral" is already dangerously repugnant, but there it is. You reap as you sow.
Speaking of crap bugging me:
""The sooner we get this relief in the hands of the American people, the sooner they can begin to do their job of being good consumers," Boehner said.
The cash premium is supposed to be reflected in the interest rate.
I'm still confused as to why the homeowner shouldn't take a commercial world approach...My conclusion is that if I live in a non-recourse location, I have a mortgage, and an earthquake levels my house, I'm going to walk. If asked, I would tell the lender on my next mortgage that I would absolutely do the same. My presumption is that this is rational behavior that should be reflected in the interest rate. That's my understanding of the deal.
"Tanta writes: In other words, investors did not adjust their options analysis model to take into account the fact that a historically unprecedented lending practice (no down based solely on a FICO) would create 'puts' where there did not used to be 'puts.'"
If I understand your post and your subsequent comments, you are trying to describe the current situation (positive analysis) rather than evaluate it (normative). If that's the case, I agree with you.
But I think the rubber hits the road when you label the borrowers "ruthless." Can't we just as easily label the lenders "ruthless" for engaging in these loan practices, at the expense of investors? Isn't making these loans in the first place just as ruthless as strategically defaulting on them? Your post concludes with various ways to avoid ruthless defaults. Do you have any recommendations for avoiding ruthless lending? What should the investors do to bring lenders back in line?
The cash premium is supposed to be reflected in the interest rate.
Yes.
But it has not been. You may, for instance, understand "teaser" rates on ARMs as a failure to front-load the option cost.
Every lender knows every borrower would "walk" (or be forced to walk, since you have to find shelter) if the home were destroyed. That's why we force you all to insure it.
You are welcome to get commercial loan terms. I for one have advocated for a long time that all investment property loans should be in the commercial portfolio, not the resi 1-4. The only reason they aren't is that Congress considers there to be some "social good" in basically offering subsidized interest rates to small-time RE investors.
So we're in agreement here. If you want to speculate, you will pay a higher interest rate on your mortgage loan. Unless Congress intervenes to artificially lower the cost of speculative mortgage credit by taking it all the in FHA program.
ella wrote
"OK, so what does this mean going forward? Will the mgt. bailout inflate that housing market? The refi mgt? The credit bubble?"
None of the above, the piranhas are now looking for new meat to devour because the consumers' bones are picked clean. They want to clean their balance sheets by transferring all of the sewage onto the taxpayer so they can free themselves up to pump the next bubble (emerging markets credits/commodities, whatever will react to easy, extortionate money). Mortgage financing/securitization is dead for at least 10 years, or until a new generation comes along without direct experience of all the BS that went on this time around.
"Would that be the banks dumping it onto the taxpayer via refi's. sold to the GSE?"
that's an interim step. the second one of that is for the federal government to explicitly assume the debt through the recapitalization of the GSE's or by taking on the toxic waste directly into a federally sponsored fund. another way is to have the fed buy the MBS paper from the banks at a price that is higher than the market price (already happening), but when the time comes for the banks to retake possession of this paper at that value plus interest, the banks refuse to honor the contract (not happened yet).
Can't we just as easily label the lenders "ruthless" for engaging in these loan practices, at the expense of investors?
Look, I didn't make up the term "ruthless." I guess I should have made that clear. Do some Googling, if you like.
We can decide to call them something else, if "ruthless" upsets everyone so much. But I will insist that you have to be wary of the "fig leaf" effect.
As it happens, I have labeled mortgage lenders "sociopaths" (UberRuthless, if you will) so many times in posts on this blog in the last year that I have lost count. I just didn't do it in this particular post.
My proposal is in the last paragraph. Require reasonable down payments, get real about appraisals, and forget about just shoving the problem onto the taxpayers via FHA. Get used to everyone paying a little more for mortgage credit in exchange for a less lethal RE market.
I have no problem with the idea that investors have to take the hit for having written puts they didn't price correctly. But the U.S. Senate is not currently working on a bill that requires MBS investors to take it in the bottom line. They're working on a bill that tries to bring back the punch bowl.
"unprecedented lending practice (no down based solely on a FICO) would create "puts" where there did not used to be "puts.""
One could view a non-recourse loan as call option on the asset. The premium is your interest payment. The strike price is the purchase price minus the initial equity or money down.
"My proposal is in the last paragraph. Require reasonable down payments, get real about appraisals, and forget about just shoving the problem onto the taxpayers via FHA. Get used to everyone paying a little more for mortgage credit in exchange for a less lethal RE market."
Non-recourse loans include typical California purchase loans used to buy an owner occupied residence of up to 4 units.
State Law protects borrowers from personal liability on a purchase mortgage for a home which they occupy at purchase. (If the borrower later converts the home to rental, he is still protected.) The State has put the risk on the lender; the most a lender can do is take back the house. This law applies to properties of up to 4 units, and applies only to loans used to purchase the property.
Purchase loans include bank loans and seller carrybacks.
This applies to JUDICIAL FORECLOSURE as well as A TRUSTEE'S SALE. So in California you can walk away without any personal liability. Which should keep lenders from making silly business.
Ella writes:
"'The Senate plan does not include the proposal by the House to increase the limits on conforming mortgages that can be bought by Fannie Mae and Freddie Mac, or insured by the Federal Housing Administration.'
That is an odd twist."
There was a blog post just a few days ago saying the people who trade the securities the GSEs issue don't want them buying jumbo loans since its messes up their models.
I quake and quiver inside whenever I hear anyone start talking about how they're going to help me do anything with my "hard-earned" dollars. Somehow, their help always seems to involve getting my government deeper in hock to China.
(Whoops, now we're WAY OT, and I ain't talking "Operating Thetan"...)
per Wikipedia: "Even though FHA is statutorily required to be budget neutral, the GAO is projecting taxpayer funded subsidies of half a billion dollars over the next three years, if no changes are made to the FHA program... [though] new budget numbers are projecting "windfall revenues" for FHA due to the collapse of the subprime market and a flood of new loans being originated with FHA."
Any thoughts Tanta to FHA increasing their fees to live up to their budget-neutral mandate?
Allen M-Your arguments are reasonable. And it is certainly not the time for measures to liberalize building restrictions to lower prices. Still, I think it takes more than low interest rates to drive prices up. Goods where supplies are elastic (cars, computers, golden retrievers) will not shoot through the roof, no matter what Greenspan and Bernanke do. It requires highly inelastic supply constraints as well.
By the way, if some poor slob can only keep his house by letting out rooms to college students, I'm not sure the law should forbid that, provided fire and safety codes are abided by.
now a person will have to get an economics and law degree to figure out how to own a condo
Well, since the whole point of owning a condo is to not have to figure out how to start a lawnmower or clean out gutters, surely you've got some extra free time there . . .
Reminds me of some papers I had to write that were supposed to be at least so many pages, but the topic could have been completely covered in 1 paragraph.
Aheadofthecurve writes:
"If you want to invest for the future (as you should) than you need to acquire a share in what Marx called "the means of production".
So AHC, tell me, given that you spend all day posting on this blog, just what are you producing?
Like most sociopaths, they dont understand why ruthless would be considered insulting or what this term social acceptability might mean.
Tanta, I resemble that remark. One may not actually be a sociopath; he might simply have an MBA. Although, I suppose, judging by actions there is very little difference.
Oh, I forgot to say. Fabulous post, if feedback from some anonymous dude on the internet means anything to you. Explaining convexity to civilians would make my knees tremble and not in a good way. Very well done.
Some appear to argue that corporations can default on legal obligations or breach contracts at will with no adverse consequences, so why not individuals. I don't think that corporations find such/defaults breaches that simple or cost free.
If people decide it is fine to borrow someone's money and decide they have no moral or legal obligation to pay it back, they should not be surprised to find that credit becomes either unavailable or very expensive.
Of course this apply as well to innocents who made no such conclusion.
Just as they misjudged the advisability and cost of borrowing too much to buy an asset inflating in a bubble, the "ruthless" should not be surprised if it turns out that they misjudged the advisability and cost of exercising a "put" that they did not pay for.
I do find it odd people get upset by "ruthless". Would they feel more comfortable with the term "pitiless"? If I were in the situation,oh yeah, I'd be ruthless. But then, I've got way too many points in common with sociopaths (except I've got more friends). I see the danger to the fabric of society, but then, I see similar dangers all around, consumerism, the cult of personality, and anything on "reality TV". I see so many problems I don't know which to be most afraid of!
But as a relatively ruthless bargainer, I do understand that I'll do better in the long run by considering the situation of my counterparty.
Back on track- I'm not afraid of the government proposed solutions, they're not going to make that much difference and we will get back to the rational way of loaning money: as if it were your own.
I didn't make up the term "ruthless"
No, but you're using it, and it is pejorative.
I call someone an "asshole." Then say, "Hey, no offense. I didn't make up the term 'asshole'."
I would say that people who walk on non-recourse mortgages are ethical, non-sociopaths.
Ethically, morally, and legally, an individual has a greater responsibility to her family than to a bank. If she can get a better deal for her family by stiffing the bank, she should.
The promissary note she signed said, "Binding under the laws of state XX" Well, if state XX is non-recourse, then the ability to walk away IS PART OF THE CONTRACT, whether the bank (or Tanta) likes it or not.
Sociopathic would be unnecessarily sending money to a banking institution instead of using it for one's family. An individual's fudiciary duty is to the family, not the bank.
BD - from your link, the first use of "ruthless" in this context was only in 1984. Mortgages have been around for centuries, and defaults are as old as mortgages. So what was it called before 1984? It's not like the Foster and Van Order paper forced us to use the term.
I run a very large escort service. My escorts mostly work at night. As for the product, I will leave that to your imagination.
Aheadofthecurve | 01.29.08 - 7:06 pm
I don't need my imagination, my point was we all have our own forms of ruthlessness, yours apparently being the use of research funds to pay your salary while you post on this blog all day.
Tanta sez: Of course this behavior is "ruthless." For many people it's quite rational, but default is default. My whole point was that people are looking for reasons to escape the term "ruthless."
I don't buy this. They're looking to escape the possibility, that they're unaware of, of being labeled with the term "ruthless," which if I understand you correctly, is your pet term for this behavior? Gee, and here I thought that they were just trying to stop putting money into a sinking ship because they judged it worse than the resulting stain in the credit reports.
I think the psychological therapy tone of this whole post is just silly. Lenders have been pricing their loans irrationally, based on the assumption that the borrowers will also act irrationally by hanging on to an upside-down debt that either (a) the law says they can't be forced to hold on to (non-recourse), or (b) the lenders don't intend to pursue the borrower for (unwillingness to pursue judicial foreclosure when available).
There is no law of nature that says that thou shalt not default on your loans. You always have the option (in the everyday sense) to do so, and you have always have had that option. The consequences of exercising that option (pun not fully intended) are spelled out by law.
Any notion that there's a moral duty to pay your debts beyond what's required by law is simply a way to intimidate borrowers into acting irrationally so that lenders may make that much more money out of them. Why shouldn't it be the other way around? Why shouldn't it be the moral duty of lenders to forgive debt when they're in a position to do so? Why shouldn't it be lenders who aim to maximize their earnings that earn the label of "ruthless"?
Corporations were invented, and not recently either, to promote enterprenureship by eliminating personal liability, such that all you would lose in a failed enterprise was was you put in. That can be counteracted by a personal guaranty. Banks ALWAYS demand personal guaranties in the case of loans to small businesses, and that usually means that the wife signs too.
In the 80s, and 70s too, I heard a lot about equity kickers, and shared appreciation. So the lender would get a slice of the pie if prices went up. I see nothing wrong with that, if the lender let the borrower walk if things went sour. Not sure there is a legal framework for it, but see nothing inherently wrong with it either.
Mrs Ruthless 60 minutes wouldn't like that at all tho.!!!
Wonderful stuff. Sorry you had to get sick to add to this wonderful blog, but perhaps it is like Machievelli being kicked out of Venice? Florence? Or Galileo being put under house arrest. They did their best work once they were out of the heat of the fray.
If homeowners deserve to break their contract, then why not banks? I propose letting banks break the contract too, at any time by giving banks a free call, where they can obtain ownership of the house by paying off the owner with any accumulated equity.
Of course, once the owner has a free put and the bank a free call, isn't that the same as renting --- any accumulated rise or fall in prices goes to the bank?
Just because we as a society are willing to offer people a second chance if they break their promises through mistakes, that doesn't make it morally or ethically right to ruthlessly break ones promises. Those who do, I'll make sure please tell me so I'll know to never trust.
I agree with Tanta. Rationalizing the situation away is rationalizing.
i sincerely wish i had the time to read all these posts.
1) allenM - you may be one of the wisest, well-positioned people i've come across on the intertubes. you and dryfly and can duke it out for the title of 'nyah nyah nyah' at some point, and yet do it with humility. its reassuring.
2) tanta - this, again, is excellent stuff and i learned a ton reading it even as i've traded convexity in the past in my fixed income hedgie days
3) nothing. and i mean nothing, is as GOOD or BAD as it seems.
4) making projections about financial stuff is about as accurate as weather predictions. constantly refine, constantly revise, and constantly make proclamations.
that last #4 is probably my most astute comment ever on CR and it'll be buried under the weight of a 300 comment thread, but nonetheless there it is people!
This is a wonderful thread!
It reminds me of discussions that a teacher from years ago used to bait students into (high school teacher). The question is: it is the last 2 minutes of the basketball game and you are playing on the losing team. To get the ball back, you foul an opposing player. Is this ethical?
Is a 'foul' unethical because it is a violation of the rules? Or is the foul and subsequent punishment all part of the rules so that it is ethical to foul as long as you accept the consequences?
Is a 'foul' unethical because it is a violation of the rules?
After watching twenty minutes of NBA basketball in the 'last two minutes' I can't imagine why even a high school student wouldn't realize that it's the strategy. Obviously, pre-Hack a Shaq.
quartz said: Some appear to argue that corporations can default on legal obligations or breach contracts at will with no adverse consequences, so why not individuals. I don't think that corporations find such/defaults breaches that simple or cost free.
Um, or perhaps you're just not reading these people's arguments well enough or charitably enough.
The precise nature of people's and corporation's obligations to pay their loans, whether a contract exists at all between two parties, exactly what obligations are created by the contract, and what consequences follow from breaching them, are matters of law.
I can understand arguments on moral grounds that the law is inadequate. I can even understand arguments that there are moral problems that the law has little power to fix. What I can't understand is the expectation of a lot of people here that a borrower should voluntarily bear the consequences of a financial burden that, either by law (non-recourse) or by the lender's choice (to not seek judiciary recourse), the borrower does not have to bear.
If the lenders mispriced their product, they don't get to bully the borrowers into keeping the cash flowing by calling them names.
Tanta...I just left a small tip for you all....anybody that can explain pricing of MBS and in the same document try to explain "ruthless" puts is a hero in my books.
I found your entry to be very thought provoking...I only hope the political types try to understand 5% of what you are trying to explain before they run off and try to solve our mortgage mess......
a sudden desire to understand just how I got where i am, and what forces are at work brought me to CR. Fantastic post Tanta, thank you.
ill take the ruthless brand, not because i am a sociopath, but because the kettle knows what color it is. and also because i know Socio the CEO is equally ruthless.
A couple of points:
1) Trolliness is in the eye of the beholder. Greasemonkey and Killfile do a wonderful job of letting each person decide who they want to hide under a bridge.
2) A critical point about MBS pricing that may have been mentioned but I might have missed.
People who price mortgage-backed securities have always known that the prepayment behavior of mortgage loans is impacted not just by prevailing interest rates, but also by the borrowers creditworthiness, the lenders risk appetites, and the cost (time and money) of the refinance transaction.
It should also be mentioned that prepayment behavior is interest rate path dependent. This simply means that prepayment activity will be faster in scenario 1 than 2:
scenario 1) rates go from 9% to 8% to 6%
scenario 2) rates go from 6% to 8% to 6%
We are currently in a situation that resembles scenario 1. As such, most able borrowers already refied when rates were crazy-low a couple of years ago.
Does anyone have a quick rundown on the legal implications of defaulting. I know CA is no-recourse which I assume means the lender can take back the house and nothing more. What about other states?
Can a defaulting borrower be pursued in court and have other assets seized or wages garnished?
"The industry has, in fact, created the conditions in which its rational, and as long as its rational it will go on."
The clear fact is that investors and bankers chose this course of making it rational to default by giving no down loans. With 20%, or even 10%down, there wouldn't by a cost free put. But whose fault is that - the guy who was 'writing "free puts"'.
So in the end, I agree with you completely, except for why you wrote a gigantic post criticizing the guy taking "free puts" when you know full well its the guy writing "free puts" that is to blame.
"Chad Peterson writes: So in the end, I agree with you completely, except for why you wrote a gigantic post criticizing the guy taking "free puts" when you know full well its the guy writing "free puts" that is to blame."
This is exactly right. I tried to make this point, but foolishly left in the word "ruthless." The issue is not the word "ruthless" (hell, call it cucumber), but WHO is being labeled. Here, the lender is, er, cucumber, for having made the loan (and collected the fee).
Tanta, you get what you give! The bankers and their cohorts were engaged in fraudulent activities that would have been illegal if they had not written the laws. Like my lawyer use to say, you lie with dogs, you get fleas
DV01st!
Whines: This post is too loooong.
First?
Now that aptly and crisply sums up what I have been talking about.
The markets will no longer continue to function without pricing in a huge risk premia, and that risk premia will force house prices much lower (due to payment increase).
The real solution to this was to allow wages to start rising quickly.
However, that is a solution that the FED will fight to the death, so now we are in a corner equilibria with a constrained solution set.
Too many houses, too little income to cover higher interest rate mortgages necessary for investors to accept negative convexity.
One other topic that goes with this- lengthening duration throwing sand in the gears of perpetual refis and sales of gse covered MBS bonds.
Save that one for another day;-}
Someday this war's gonna end...
This is such a great post - I guess I'm not the only one who spent their former life geeking over OAS and convexity.
One question though - regarding the "default put" - don't most refis have recourse to the borrower?
UberNerd on tape/CD?
Don't want anyone to miss the superbly ruthless website posted by REBear on the previous thread:
You Walk Away - Foreclosure Protection Plan and Kit, Mortgage Loan Modification, Foreclosure Assistance, Debt Consolidation, Credit Repair from Foreclosures
You Walk Away The Personalized Plan
I especially like the pictures of happy families packing up boxes as they prepare to walk away.
"The trouble is that convexity involves a whole bunch of seriously geeky math and computer models and normal people probably dont want to go there. (I dont even want to go there.) So as a compromise, this is a very quick and simple explanation of convexity."
Awww, but I like geeky math... But then again, my biggest frustration with my career with an engineer is that I don't get to do enough calculus. Anyhow, it seems that the other way that lenders can encourage repayment of their loans is to aggressively pursue legal judgments against people who default in states that allow them and to try really hard to get those who committed actual fraud prosecuted. In fact, it might make a good deal of sense to do this even in cases where there isn't a good chance of additional economic recovery to increase the risk and headache of choosing to default. Another thing that lenders might want to try is an MPAA like advertising campaign in which they remind people that they are responsible to pay their debts.
One question though - regarding the "default put" - don't most refis have recourse to the borrower?
Another great example of why this shit's so hard to model.
Yes, refis are generally recourse. However, "recourse" really means that if the lender wants to go after you for a deficiency judgment, the lender must choose judicial FC. (Some states, of course, require only judicial FC, like OH. But in states like CA, there is a choice of non-judicial/power-of-sale FC or judicial FC.) So then it becomes a question of which ends up cheaper: winning your deficiency judgment (which you hope the borrower can pay) by spending more on court costs, or just writing it off and going the non-judicial route.
As it happens, loans that are already refis (that are originated as refinance loans) have different prepayment characteristics than purchase-money loans anyway. (All other things being equal, once it refied the more likely it is to refi again if it's in the money. The "efficiency" with which purchase-money borrowers will refi is more uncertain.)
Congratulations on your thesis.
The Trustees of CR University, to whom these presents may come greeting be it known that Tanta, having completed the studies and satisfied the requirements for the degree of Doctor of Mortgage Puts & Calls?, has accordingly been admitted to that degree with all the rights privileges and immunities thereunto appertaining.
Gee, you say "sociopath" like it's a bad thing.
Anyhow, it seems that the other way that lenders can encourage repayment of their loans is to aggressively pursue legal judgments against people who default
In essence, I think the problem we're having at the moment is that lenders will never do this until ruthless puts get to be a big problem. They never act "proactively" because, you know, they have to report the expenses of doing that.
Tanta,
Maybe the possibility of "exercise of the put option" is not in the contract but in a non-recourse state, it is implied by the law. I can't find such behavior ruthless.
In the good old days, there was guarantee that it is not worth to default, called downpayment. Just like VIX was incredibly low in 2006 "Goldilocks-economy", the lenders thought the price of this "put option" was minimal and mispriced it.
Tanta, one of the problems is that you are not throwing rocks at the insane mortgage models used by wall street to value the exotics and subprime.
How could anyone seriously buy stuff like that for 101% of face value? Was there no thought of any losses on the part of bond purchasers?
In other words, wall street distorted the entire mortgage market by hatching a bubble that once going, was perpetuated by tranche slicing.
In other words, they built the bubble, and now they complain that it blew up. Make wall street take their losses and now the government needs to step in and correct the market failure that is now becoming obvious.
Bah, this is taking too long to reach bottom, and there seems to be yet another false dawn while we talk about real crisis in the machinery.
Someday this war's gonna end...
--
Options Theory doesn't help price fraud. Once you have a totally fraudulent activity, even though it is legally sanctioned, all pricing mechanisms are doomed to failure.
Made a killing of long-term puts on Fraudentials (sold 65% at average of 6X and still holding 35%),
Jas
In the good old days, there was guarantee that it is not worth to default, called downpayment.
Exactly. The social purpose of non-recourse laws is not to give ruthless borrowers a put. It is to remind lenders that if they are stupid about LTVs and appraisals, they are giving ruthless borrowers a put.
Of course this behavior is "ruthless." For many people it's quite rational, but default is default. My whole point was that people are looking for reasons to escape the term "ruthless."
I could be way off, but it seems to me the problem cannot be confined (contained?) to the relationship between the borrower and the lender. We are, and have been, to my understanding, talking about bankruptcy of the borrowing party. The lenders will seek judgment and/or criminal fraud actions against those who simply "walk-away". Once that happens, the income and assets of the defaulting party will be attached, and that ain't gonna' be pretty.
Am I missing something, here?
Tanta,
"The only situation in which giving the house back to the bank would literally be possible is if you bought the house from the bank (say, it was REO) and the contract explicitly gave you an option to sell it back to the bank, whenever you wanted to, at a price equal to your loan balance. Nobody writes REO sales contracts that way."
Hmmnn. It appears to me that there might be a role for an explicit (rather than the current implicit) put, here. Write the mortgage and embed a non-tradeable put.
Convexity - ask and ye shall receive. With Tanta it comes both barrels at once...
Thanks T - now I'll have to kill some trees to read this one.
Marcus,
I know several fraudsters who are confident that the banks won't pursue them even though they've defaulted (or are about to default) on their loans. I really think that there is a widespread perception that the worst thing that can happen to you in foreclosure is that you have to give up the property.
Hmmnn. It appears to me that there might be a role for an explicit (rather than the current implicit) put, here. Write the mortgage and embed a non-tradeable put.
That has been suggested.
Good luck building a model that lets you price it.
There was a time when some S&Ls basically did write puts on REO sales. Then they blew up and the regulators got pissy about the subject. If you sell REO that way, you carry the liability. I don't think many of these institutions could afford to sell their REO with a repurchase agreement.
We are, and have been, to my understanding, talking about bankruptcy of the borrowing party.
That's the "distress" default.
Actually, we are talking about non-bankrupt defaults.
Marcus - I think the real issue is that we're NOT talking bankruptcy, we're talking people who can easily afford to make their payments, stay up to date on their credit cards, probably even sock money away in their 401ks. They've just decided that there is a financial benefit to defaulting on their mortgage loans. And the love of their homes, their communities, their children's schools, is no longer enough to outweigh the financial benefit. It's a rootless society that just follows the money.
If I lent money to a risky small business, some part of my payback calculation includes the probability of the business going BK, and this used to be done for individual borrowers as well. The idea that I will lend money at the same rate (or at all) always had to include not only what happens in good times, but in bad. It was "ruthless" competition on the part of the lending conduits which caused them to slash their rates below what their risk equations must have told them would be the consequences in bad times; or to hide those equations altogether. Too much lending capacity, just like to many factories producing buggy whips, and at some point it falls over.
Tanta, one of the problems is that you are not throwing rocks at the insane mortgage models used by wall street to value the exotics and subprime.
You mean I'm not talking about the insanity of pricing credit risk. No, I am just trying for once to talk about something other than credit risk. There have always been and will always be optionality issues with non-exotic prime loans. In fact, the "ruthless" borrower is most likely to have prime credit.
To be honest, there wasn't always all that much wrong with those models. All you have to do is extract the assumption that RE always appreciates, and they work fine.
Nihilist Anarchist Rationalizers. Too bad NAR is already taken.
Shouldn't terms and conditions to mortgage loans be adjusted to remove the convexity? Requiring a down payment and early prepayment penalties obviously skew towards this goal. I guess the only reason convexity and therefor in the money puts were allow to persist was because there was an upstream market that was willing to accept them. My sense is that the solution will come from that side of the business as well. New loan standards will be based upon what can be resold. That leads us to the impending horror of the GSEs preparing to be the repurchaser of last resort.
Thank you Tanta for this most illuminating OberUberNerd Monograph (not to be confused with a monoline).
--
"I know several fraudsters who are confident that the banks won't pursue them even though they've defaulted (or are about to default) on their loans."
"fraudsters" know that if they defraud other Fraudsters they are relatively safe.
Kill poison with poison: Let one group of fraudsters kill the bigger group of Fraudsters!
Jas
Wow, Tanta. That is better written than 99% of what I read.
Is there a list somewhere of recourse vs non-recourse states?
They've just decided that there is a financial benefit to defaulting on their mortgage loans. And the love of their homes, their communities, their children's schools, is no longer enough to outweigh the financial benefit.
And where in the world would they get the idea that their purpose in the world depends primarily on the financial benefit that they generate to society?
This is gonna take some serious slogging. But as Robert Venturi said, "less is a bore".
Thanks Tanta
The only possible way to get back to an environment in which ruthless default is rare is to abandon the innovations that give rise to them: no-down financing, wish-fulfillment appraisals, underpriced investment property loans, etc.
What surprises me is that the industry is not smart enough to have already abandoned these "innovations" or at least starting pricing them appropriately. Why the industry is originating or why investors are still buying high LTV loans without a huge premium on the yield is beyond me.
It's not that hard to price the implied puts. Any reasonable assumption about home price volatility and underwater buyers defaulting will show a substantial premium for writing the embedded put.
I repeat what I said on a previous thread. There are not enough judges and minions of same to begin thinking of collecting on more than the most minor percentage of hypothetical dificiency judgements. And the banks and lenders continue to cut their personell. If this was to be done, it would need lobbyists in the most hard hit states to start a foreclosure court, with extra high filing fees, said fees to pay for the extra judges, minions, sheriffs, and courtspace. Filing fee in Miami is, umm, a bit more than $250.00. Would the banks pay triple, say, just a guesstimate, to file to pursue a deficiency judgt along with the foreclosure, even to get fast attention? I doubt it.
Their business model is firing people and cutting costs. Pursuit of deficiency judgts might mean everybody else in civil court will have to wait longer. Maybe mean that in Miami, say, you might have to pull judges away from doing divorces and child custody, and probate and mental health work to do dificiency judgts. Frankly, it's not gonna happen. Keeping divorcing spouses from killing each other and keeping kids with the right parents is far more important. Not that the judges do a good job at that, anyway. They are too overworked, and the "system" is underfunded for kids by at least one half.
Tanta
Even for someone as thick as me, this is great.
I guess the only reason convexity and therefor in the money puts were allow to persist was because there was an upstream market that was willing to accept them.
Not necessarily.
One way of looking at is is that the social goal of increasing homeownership was achieved at the cost of convexity problems. Of course you can ask everyone to make a 20% down payment and accept a prepayment penalty. You therefore rapidly decrease the pool of home buyers and sacrifice workforce mobility. You can also make everyone take ARMs whether they want to or not. While there are some convexity issues with ARMs, it's nothing like the curve you see with FRMs. Our expectations are that people can have not just cheap mortgage financing, but fixed rate inflation protection.
Somebody decided we could have it both ways: an "ownership society" and cheap mortgage rates.
Lenders never thought prices would fall this fast when the $ tap was shut off....now the model is broken since refis don't work so good.
As you inferred, people who are made to feel 'ruthless' thru correspondence from the lender when turning in the keys should just repond with the old childlike one-liner: 'Takes one to know one'
I think they feel their purpose is more along the lines of the financial benefit they generate to themselves.
And where do they get that? Angelo, maybe...
Re: You Walk Away - Foreclosure Protection Plan and Kit, Mortgage Loan Modification, Foreclosure Assistance, Debt Consolidation, Credit Repair from Foreclosures
"
7. \t How much is your service?
A. \tWith our money back guarantee, you get it all for only $995.00.
"
Is this for real, or is it brilliant satire?
Tanta- Canada has reasonable rates of homeownership (somewhat less than the US, but still very respectable) with no fixed-rate mortgages, no zero-down and mortgage interest is NOT tax-deductible.
Speaking of "puts", I came across this website
You Walk Away
A company to help you make this put decision
In florida at least it is really tough to collect on a judgment against an individual.
Re: Canada
Actually latest data I could find was from 2005. US was 69 %, Canada 67%. All without fixed-rate or 0 % down and interest is not deductible.
So, none of those things are essential for homeownership
The lenders going after them for fraud may be exaggerated. Fraud cuts both ways if the lenders were somehow being fraudulent. I'll bet these attorneys drumming up the walk away business are looking for patterns. If lenders initiate actions and facts come out against them, the class action bar will be sitting there salivating. Hell, I wouldn't be surprised to see them goad lenders into the public arena of the courts to gather free "intelligence".
(On You Walk Away)
"I especially like the pictures of happy families packing up boxes as they prepare to walk away."
Yeah, that's bizarre. Shouldn't they look grave? Wistful at least?
7. How much is your service?
A. With our money back guarantee, you get it all for only $995.00.
Do you take credit? I promise I'll pay you back.
increasing homeownership was achieved at the cost of convexity problems.
Okay, that makes sense.
Of course you can ask everyone to make a 20% down payment and accept a prepayment penalty. You therefore rapidly decrease the pool of home buyers and sacrifice workforce mobility. You can also make everyone take ARMs whether they want to or not.
That would be Australia. Unfortunately they seem to be having many the same troubles as we have.
I am surely happy to have my 4.99% 30yr and Prop 13. While rates are dropping, excuse me, being forced lower now eventually inflation will be unable to be ignored. If the current crop of FB refi to low fixed and then this happens they might be okay but at the expense of banks being even worse off.
Not trying to be hard-headed (we are what we are), but what's to stop this scenario:
Either this scenario will play out as described, or theft by fraud has found a legal loophole.
Presumably the currently typical decision not to pursue borrowers in recourse situations for the deficiency is rational, and based on an assessment of the legal and administrative expense of doing so, as opposed to the anticipated recoveries. In other words, why try to get blood from a turnip?
Two probable circumstances are going to compel a reassessment. First, if the problem becomes common, those legal and administrative expenses can be reduced significantly on a per file basis as they are spread over a much larger caseload. Second, more and more of the turnips are going to be worth squeezing. The whole endeavor will start to resemble something like collecting past due child support.
Finally, if the 'ruthless' problem becomes widespread, a certain amount of exemplary justice, per encourager les autres, may prove effective.
These observations are offered without any attempt to address the political fallout from more aggressive recovery efforts.
Tanta - Looks great I wish I had time to read it all.
Two suggestions:
A) add PODCASTS to accompany posts of this length/topics of this depth.
B) hire James Earl Jones to do voice for A above.
James Earl Jones is already the voice for the pig.
who coodanode that mortgage pig had fat tails instead of cute curly ones....
Shouldn't terms and conditions to mortgage loans be adjusted to remove the convexity? Requiring a down payment and early prepayment penalties obviously skew towards this goal.
You can't remove the convexity. As long as the law requires that pre-payments be legal, you're still going to have that positive slope at the left end of the graph.
Writing from California which still has the 'one form of action' rule*
One thing I noticed a lot -- people would get a mortgage then talk about being just deluged with phone calls, several a day, from the very same mortgage lender -- offering better deals starting immediately. It didn't make sense until I remembered.
One form of action -- the rule only applies to first morgtages.
If you want to block someone from having that legal protection, get them to refinance.
Clever lenders? The big fast mortgage shops must have known they could remove that protection and get access to both the house and the other assets on default, if they could get people to refinance.
And if they knew they were making loans with a high likelihood of eventual default, and the business model was to get at both the houses and the other assets, this would be a tactic.
Til I thought of that, it struck me funny how the mortgage that was "the best available terms" one week was always possible to improve on, and at such low cost, the next week. And why were they so actively phoning their first mortgage customers trying to give away money like that?
Anyone who lives out here knows, the phone would ring several times a day -- any phone, anywhere -- with mortgage calls.
Or maybe I'm too suspicious?
Nah.
The administration is currently pushing for increasing the FHA loan amounts and the FHA maximum LTV up to 100%. This is not likely to remove the incentive to take another reckless loan on a still-too-high-priced house. If we arent going to ration credit with tighter guidelines and loan limits, then it will have to be rationed with pricing: eventually the models will solve the problem by increasing the costs of mortgage credit. You cannot simply keep writing free puts.
This is so well written.
And, then you goto somewhere like quickenloans.com and see all the current ways they try to provide no/low downpayment financing.
A LOT of people still don't get what makes a healthy real estate market.
I believe that there is a real option.
I am not saying it is legal.
It is an exchange option: put on the House and a call on the future payments (rather than the "House price").
aotc- please take the time post a graph or table w/ price-to-income ratios for various Canadian cities.
On Ruthless Default...
Ultimately, there is no way anyone can mobilize social acceptability as a defense against the ruthless put (even if you wanted to). The industry has, in fact, created the conditions in which its rational, and as long as its rational it will go on.
Bravo, Encore, Encore. The bankers must reap what they've sown. No Tanta (or her ilk) in the underwriting department means these sorts of problems are going to crop up. Moreover, even if they bring Dr. Tanta back now (at a much high salary than before) its too late to stem the bleeding.
Tanta,
"Like most sociopaths, they dont understand why ruthless would be considered insulting or what this term social acceptability might mean."
Ow! That hurt. Well, ok, maybe not really. Though I think your comment might be more applicable to basic human nature than you think. Attached is a nice workup that basically amounts to answering the question "Why didn't the average Soviet citizen exercise a 'Stalin Put' in 1942?"
http://www2.warwick.ac.uk/fac/soc/economics/staff/faculty/harrison/papers/totalwar.pdf
People can be darned cold-blooded. In any case, your answer on the embeded put idea is interesting. At first blush, I'd figure modeling an explicit put would be easier than working with the current "Will they, won't they?" environment. If a lender is selling you such a put, they are sending you a signal about their thoughts on the direction of housing. Under the current circumstances, some transparency might be a selling point. I smell opportunity! :^)
"My whole point was that people are looking for reasons to escape the term "ruthless.""
The word does not occur in the contracts, only in your trade jargon. The traditional defense against the default is, as you nicely point out, is in the original structure. You have a premium for the risk or you require skin in the game. (In either case, you do not need to resort to name-calling to be protected). In some circles, skin in the game is reinforced by a kneecap or two in the game. It has always worked.
Tanta,
Thank you for crispness, clarity and at long last convexity.
Someone's comment earlier today invoked a reversal of the usual moral hazard argument (viz, if you keep paying irrational LOs you just get more of 'em) as a defense of jingle mail. I'd say that Spencerian moment, if there's to be one, comes only at the closing.
Tanta, you are in your element today! Great post - this really clarified things for me.
Lemme see if I get this straight... when an individual does it, it's called "ruthless default," but when a corporation does it, it's called "meeting fiduciary responsibility to shareholders."
Imagine my surprise to discover that financial corporations might be concerned about the social acceptability of individuals doing what the same corporations are regularly lauded by the financial press for doing themselves, i.e. letting bad contracts go to liquidated damages when that turns out to make more financial sense.
Marcus, issuing the judgment and dunning income are two seperate things ... court has no problem issuing the judgment but dunning the income without the debtor being present? Might be the same as making a family homeless ... judges have to run for re-election here ... nobody is going to risk taking the food off the family's table.
Tanta,
Thank you for the amazing post.
What would you consider the possibility that mortgage lending will be further socialized through the GSEs? In my ignorance, I perceive another possibility: somewhat tighter guidelines, somewhat rational loan limits, with the risk downside guaranteed by the gov't to avoid risk re-pricing.
Not trying to be hard-headed (we are what we are), but what's to stop this scenario:
Nothing stops that scenario.
But these mortgage pools were not priced originally assuming that's how they'd get principal back.
Try it this way: what discount rate would you use there? How long will it take you to get your money?
aotc- please take the time post a graph or table w/ price-to-income ratios for various Canadian cities.
Here is a link to a recent study from RBC.
http://www.rbc.com/economics/market/pdf/house.pdf
i think we're suffering a walkaway bot invasion :
"You cannot simply keep writing free puts."
There is/was implied premium in a high FICO score. At some point in the future you can create a simple graph of defaults with FICO scores and negative equity as variables. You can imagine the shape of the curve.
seminole | 01.29.08 - 1:02 pm | #
it's my understanding that in civil actions, if the borrower (Defendant) doesn't show up in court, the lender (Plaintiff) will be granted summary judgement (within the law and the jurisdiction of the court to grant such relief). If there is no objection from the opposing party, and the request is within the law, the moving party will get what it asks.
I could be wrong.
Holy crap, Tanta.
Someone should give you a book deal already.
In either case, you do not need to resort to name-calling to be protected
Look, this isn't about name-calling.
You could, I suppose, write a contract that never ever carries any risk to one party. (I don't know why you would, but you could.) In that case, there would never be "default."
Whenever there is any risk to a party in a contract, there is the possibility that the party will try to get out from under that risk by refusing to abide by the terms of the contract. That is called "default."
"Ruthless" is simply the term we use for borrowers who will always seek to maximize their gain, regardless of the rights the contract gives them.
Similarly, "entitled" is the term we use for people who expect to enter into contracts in which they can never lose.
What's funny about all of this is, again, the resistance to the term "ruthless." My view is that people wish to overcome their inhibitions about ruthless economic behavior without having to admit it. They therefore take umbrage over the term.
Did you watch the 60-minutes video? What other non-judgmental term would you use to describe the borrowers interviewed?
Tanta,
Thank you for the education. Great job!
""Ruthless" is simply the term we use for borrowers who will always seek to maximize their gain, regardless of the rights the contract gives them."
You mean as opposed to people who seek to minimize their gain? As I said, it is your trade jargon. I don't mean by that to say I approve or not - I would probably never default no matter how far underwater, but... I'd say 'opportunist' or 'defaulter'.
s9,
"when an individual does it, it's called "ruthless default," but when a corporation does it, it's called 'meeting fiduciary responsibility to shareholders.'"
No, it's ruthless in both cases. You can use precisely the same sort of analysis to determine when a company is likely to default on its bond obligations, with the only added complexity being the need to take into account asset volatility.
Atlas: Using the Black Scholes Merton contingent claims approach to the valuation of corporate debt to model default risk: Why Moody’s Investor Services bought KMV Corporation. by Lyle C Gurrin
(Techincally, I think you need to do the same for the underlying in the housing/mortgage case, but volatility is a lot lower.) (Ha!)
Nothing stops that scenario.
Disagree. In the current environment lenders and servicers are being vilified for the housing "crisis" for just following SOP - foreclosing when the payments stop coming in.
If they were to begin aggressively pursuing deficiency judgments where allowable it would be a public relations nightmare - and would undoubtedly incite legislation to extinguish it as an option.
"when an individual does it, it's called "ruthless default," but when a corporation does it, it's called 'meeting fiduciary responsibility to shareholders.'"
And when a government does it, it's called 'fixing Social Security.'
This is getting Shakespearean. Everyone's a fool, they all serve their own interests, there's much treachery and behind-the-scenes plotting, and everyone dies in the end.
Neither a borrower, nor a lender be...
Alas, poor Real Estate Industry, I knew him...
aotc- Thanks for the data.
Other than the 'coastal' cities, most areas seem not to have recovered from the 2000 house bubble yet, unlike the US. Plus, the down-payment required in the study is 25% !! Gee, if that type of study was done for the US, no one could 'afford' a home. If that is even remotely close to the average down payment in Canada, then jingle mail generally won't be happening like in the US, as Tanta explained.
You seem to live in one of the bubble markets..worried (yet)?
Well, I suspect that the prices/rates for recourse and non recourse loans are very similar. This would indicate that the "ruthless put" has not been priced in. Only the ruthless, not the insolvent are worth getting a deficiency judgement against.
And I'm probably not the only person to dislike the term "negatively convex." Shouldn't the term be "concave"?
Thanks Tanta.
In thinking about contracts I have negotiated, it occurs to me that one would be naive not to negotiate with the understanding that the other party is likely to behave in a ruthless manner if it becomes of significant advantage to them.
Seems to me this all gets back to the idea that if real estate only goes up, then the ruthless/jingle mail case isn't worth worrying about. Oops.
ruthless - having no pity; cruel
Sorry...if you have a secured loan and the underlying asset drops in value, value is gone. There are two interested parties, the mortgagor and the mortgagee. Why should the borrower assume the lender's loss because the lender was too foolish to demand adequate security or premium?
If I had a mortgage and an earthquake leveled my house, I'd walk. It's not a matter of ruthless, it's simply the deal. It's not an unsecured or personal loan. Bondholders are simply equity investors with a senior claim and receive interest in lieu of excess return and/or capital appreciation. When was the last time you saw an equity investor kick in money to make the bondholder whole? Why should it be any different for the homeowner?
To me, ruthless is the bank sorting clearing checks from high to low in order to maximize NFS fees.
Anonymous-I'm Canadian, but live in the US, in a fairly non-bubble market. The really bubbly markets in Western Canada are dependent on oil (Alberta) and potash (Saskatchewan). What they do will depend largely on commodity prices. Vancouver is the haven for Hong Kong money. Prices have been sky-high there for a very long time. Canadians have a much higher savings rate than Americans and generally expect to save to buy a house. The government also runs a surplus.
This is great commentary. Thanks for your insights.
Tanta- Can't this be addressed through the tax code? If you walk away, the difference between what you owe and what the bank gets in liquidation is income to you. If you are distressed (job loss, illness, etc.) this can be waived. It could also be waived if you negotiate a modification in good faith. Then the IRS can collect. They are harder to escape than banks.
My father was forced into bankruptcy by his main creditor after two employees embezzled a large sum and vanished. Most of his debt was discharged. Three decades later and after uncounted arguments with new employees at various S&L's and banks he finished paying off the debt he had been forgiven, with interest. He wouldn't have bought this 'put' business or 'Force Majeure' either.
Wow.
Tanta, a question from the dummy gallery.
So, are we to understand that Washington thought higher GSE/FHA limits would juice the mortgage market by spreading the credit guarantee blanket wider, but instead it's simply spoiling the whole bunch with bad apples? Doesn't the credit guarantee make up for ruthlessness? I wish you'd do a nerd post further analyzing the conforming limit increase alone.
Oh, and to prove I'm not a complete dummy:
Tanta,
Thank you for the carefully, well-written, appropriately long post.
Try it this way: what discount rate would you use there? How long will it take you to get your money?
Tanta | Homepage | 01.29.08 - 1:04 pm | #
The best way for people to get their head around the difficulty in pricing is by imagining a "Chinese Auction" (sorry if somebody is offended - its what I've always heard them called)...
Imagine two parties each own half of an asset and they want to have a mechanism to buy the other out. They flip a coin and Party A wins. Party A then gets to set the price for the transaction but Party B gets to decide if s/he buys or sells at that price and Party A has to accept Party B's decision. Party A has to price very carefully.
Now imagine that were going on in the mortgage world when you are in front of the lender. Imagine you had to offer loan pricing & terms to the lender and the lender decides to either borrow to you or borrow FROM you at those terms.
Now knowing what we know about early early pre-pay and ruthless borrower risk... how would YOU price the offer knowing somebody else gets to decide which way the deal goes?
I have no idea how I'd price something like that. I wouldn't want to play that game - I'd put my money in a tomato can in the back yard instead unless I could get a lot higher price than is currently the norm. But I'd probably not want to borrow at the price I'd want to lend at either.
That's what the credit market is saying right now regarding the proposals to add big chunks of jumbo to their previous creamy smooth GSE conforming soup. No thanks - I'll eat at home.
Why should the borrower assume the lender's loss because the lender was too foolish to demand adequate security or premium?
I'm not sure what, exactly, you think we're disagreeing about.
My own view is that very many, but not all, people will default if you put them in a situation in which the consequences of default are more to their advantage than not. That's why I have always been into down payments and good appraisals and all that other old-fashioned stuff. You don't enter into contracts with terms that are unfavorable to you.
There are, however, some people who understand a promissory note to be a promise that has to be kept, even if it becomes unprofitable. If you're willing to call these people "rubes" or "patsies" or "suckers," then I think you should be willing to call defaulters "ruthless."
This subject always reminds me of a hundred years ago when I was a salesclerk in a fairly upscale department store. Dealing with the return policy headache. If you take back too many ball gowns that were worn once (and cannot be resold at the price you just refunded), you'll have to do something about your prices to everyone. That's just the way it works. Otherwise you enforce more restrictive return policies that piss off people whose returns are legitimate.
I can't believe I grew up, left retail, and got into mortgages. Must be bad karma.
S9
Lemme see if I get this straight... when an individual does it, it's called "ruthless default," but when a corporation does it, it's called "meeting fiduciary responsibility to shareholders."
Then...
Allen C
ruthless - having no pity; cruel
Sorry...if you have a secured loan and the underlying asset drops in value, value is gone. There are two interested parties, the mortgagor and the mortgagee. Why should the borrower assume the lender's loss because the lender was too foolish to demand adequate security or premium?
That about sums it up for me.
Can't this be addressed through the tax code? If you walk away, the difference between what you owe and what the bank gets in liquidation is income to you.
Well, yeah, but we just changed the tax code precisely in the opposite way.
Liz...
I agree that there isn't the capacity or will to do a lot of criminal prosecution.
However, you could have some 'poster child' examples. Especially if they went after someone that fit the 'ruthless' criteria precisely. That is, someone that is sending the keys back on an expensive property and has enough income and assets that make them nowhere near hardship.
I don't know if it will be done, but it would be smart for the lenders to find some poster child examples the sooner the better.
I can't take credit for this, but it perfectly illustrates the hypocrisy of banksters accusing FBs who walk away of "unethical" behavior:
First to walk were the federal regulators.
Then the mortgage broker walked (after taking his commission).
Then the lender walked (after selling the loan).
Then the mortgage securitizer walked (after selling to pension/hedge fund).
Then the ratings agencies walked.
Last to walk was the borrower.
AllenC,
"If I had a mortgage and an earthquake leveled my house, I'd walk. It's not a matter of ruthless, it's simply the deal."
I don't think that's quite it. Keep in mind that you are not buying the house from the lender, nor is the lender buying the house and then letting you use it for a fee. You buy the house with money the lender gives you; the lender merely states as a condition that he gets dibs on the proceeds if you find yourself forced to sell. Your obligation was not conditioned on whether the house burns down, falls due to earthquake or termites or stands for a thousand years.
That said, I see nothing perjorative about saying that you'd ruthlessly protect and maximize your own value under the circumstances. Your counter-party (in fact, all potential parties) would do the same. That's the nature of an arm's-length transaction.
More practically, though, you do suffer the temporary cost of more limited access to further credit and/or greater difficulty in getting a job that works with large quantities of money. But this too shall pass....
Did you watch the 60-minutes video? What other non-judgmental term would you use to describe the borrowers interviewed?
Tanta
A. rational
and
B. normative
"Well, yeah, but we just changed the tax code precisely in the opposite way."
I know and that's ridculous. After all, gains on option trading are taxable.
To compensate we could make a real loss (i.e. lose your downpayment in a short sale) deductable.
So, are we to understand that Washington thought higher GSE/FHA limits would juice the mortgage market by spreading the credit guarantee blanket wider
You give them too much credit, in my view.
As far as I can see, they're just trying to reflate house prices. That makes the ruthless borrower go away because default is no longer the best option.
In any event, these proposals are not dispersing risk, they're concentrating it. The private investors and portfolio lenders folded, and now we want the GSEs and FHA to be lender of last resort.
... Party A then gets to set the price for the transaction but Party B gets to decide if s/he buys or sells at that price and Party A has to accept Party B's decision. Party A has to price very carefully.
My parents would let one kid cut the candy bar and let the other choose. The presumption is however that both sides want the same thing.
Marvelous post; exceptional writing. What you call "ruthless," the law-and-economics law schools (Yale, Chicago, Virginia) call an "efficient breach." If it's any comfort, plenty of my classmates balked at such efficiencies when confronted with a now-unfavorable contract. I'm certainly curious to see just how many people are ruthless, er, efficient, in real life.
That said, I see nothing perjorative about saying that you'd ruthlessly protect and maximize your own value under the circumstances. Your counter-party (in fact, all potential parties) would do the same. That's the nature of an arm's-length transaction.
Xactly. In a rapidly rising market, would the lenders hesitate one second to foeclose on a down-on-his-luck borrower that was behind on his payments, just because that would be the "ethical" thing to do? A: Hell no.
Ruthless = rationally protecting one's own in a ruthless (and rigged) game.
Covering this via the tax code is the wrong approach - that just brings in another (disinterested) third party. Its a pricing & terms issue. The market needs to price in the options risk better or offer term conditions that protect lenders from this risk (i.e. demand more down payment). In effect telling the borrowers to send us the keys if you want... we got a 20% head start on any loan losses.
Its silly to do anything else.
Here is the disagreement...
"some people who understand a promissory note to be a promise that has to be kept"
If it's a personal loan or unsecured then yes I concur.
If it's a secured, non-recourse note with a formal lien on the underlying asset, then no.
The dress buyer in your story committed low level fraud. The homeowner (equity holder) is walking away because the value is gone leaving the lender (bondholder) with the remainder. If it's secured, non-recourse, it's the deal.
Excellent post. I think too many people are whacked out about the term "ruthless".
Why don't we take a page out of Nixon's book (ala not useing the word "recession") and call it something like, "banana".
Alternatively, maybe we could rename the evil loans, "Voldemortgages".
When the banksters and so-called "regulators" start modeling "ethical" behavior as a matter of course, I'll change my tune. Until then... it's just chickens coming home to roost.
If it's secured, non-recourse, it's the deal.
No, it isn't the deal. We would not call it "default" if it were the deal.
You do not have the contractual right to substitute the current value of your home for the current balance of your mortgage.
Just wanted to say thx for any outstanding post. I've sent the link around to many folks already. Keep up the great stuff!
lessismore,
"I'm certainly curious to see just how many people are ruthless, er, efficient, in real life."
Merton rulz!
@Tanta,
Technically, the loans in a GSE portfolio are not "federally backed", and the GSEs are not "too big to fail". However, the bond market prices them and acts as though they were.
IANAL, but on a practical level, this (substituting the current value of your home for the current balance of your mortgage) seems to be the deal.
I think that "ruthless" has a connotation of violence that implies that the borrowers are kind of aggressive predators, and that is what pulls peoples' (mine included) chains. These situations have been fostered by a deliberate and fundamental aggressive activity by investor groups and lenders to foster the housing bubble, slash risk management, and commodify living arrangements under terms that were of short term profit to their owners and there is no way that you can say that on a social level that the individual "poster children" had equal power in the relationship. The fact is, people in earlier generations not only had moral imperatives holding their feet to the fire to honor their obligations, they were more often than not more deeply embedded into a lively community of support, the very communities which have been dissolved by the aggressive actions of the lenders and financial "free" markets.
The behaviour of the 60 minutes couple can be neutrally described as "selfish", certainly, but there is only one side of this story which was so tightly organized to be "ruthless", I'd say.
Anyone who thinks jingle mail is "part of the deal" with a mortgage will find out otherwise as soon as he tries to get another one.
He will then discover that the lender will charge him a much higher interest rate than he used to pay. He will ask why that is, and the lender will say it's because his credit report shows that he is a defaulter.
As someone else has already noted, the trouble in the boom was that we thought FICO offset down payment. FICO, of course, is supposed to measure your willingness not to default on debts.
FICO, of course, is supposed to measure your willingness not to default on debts.
Well, then you do get a free put.
If it's secured, non-recourse, it's the deal.
If you mean as a matter of law (or fact), you are simply incorrect.
There's the promissory note, in which the borrower (debtor) promises to repay the loan with interest. Then there's a separate mortgage (or deed of trust) executed by the borrower/debtor, which grants the lender an interest in the real estate and also contains a promise to repay the loan in accordance with the terms of the promissory note.
The mortgage is a security for the Note, it is not a substitute for the Note, which is exactly why it reaffirms the terms of the Note.
Tanta,
If that is true, then potentially millions of former FBs will become renters for life. And that will mean far more inventory to choose from at lower prices for people -- like me-- who refused to participate in this massive Ponzi scheme.
How is that a bad thing?
In a rapidly rising market, would the lenders hesitate one second to foeclose on a down-on-his-luck borrower that was behind on his payments, just because that would be the "ethical" thing to do? A: Hell no.
But it's quite rare to foreclose on the distressed borrower in a rapidly rising market. The distressed borrower can sell.
Either way, the lender just gets paid back. The sale proceeds over and above the amount of the debt belong to the borrower.
If we wrote shared-appreciation loans, now, that'd be different.
Don't the GSEs & FHA make loans to people with foreclosures, once they've passed the 2-year mark? That's hardly "forever".
Tanta writes:
Anyone who thinks jingle mail is "part of the deal" with a mortgage will find out otherwise as soon as he tries to get another one.
On a purely contractural basis, I have no problem with jingle mail. After all, business is business. What should prevent it happening is some adverse outcome - like destroying your credit risk.
Don't the GSEs & FHA make loans to people with foreclosures, once they've passed the 2-year mark?
Only with documented extenuating circumstances. In other words, only if it's "distress" instead of "put."
"No, it isn't the deal. We would not call it "default" if it were the deal."
I most respectfully disagree.
If a corporation defaults on a secured, non-recourse loan, the lender exercises their senior claim on the asset(s). If the deal is secured, non-recourse, the lender has no right of further claim. That's the deal. No?
Once again I wish you'd taught Economics at my college Tanta. Great post.
Tanta,
not too long....just right, and clear.
you are a fine teacher...maybe your next gig should be at a college...you students would appreciate your pointed explanations.
as for posters above who are exorcised about the term "Ruthless" in the mortgage industry...hey get over it...just a term
like is a "covered call" is wearing clothes and a "naked put" is when you are undressed and... just...(ok i wont go there)
Read the column on government sanctioned re-writing of mortgage responsibilities. In Congress they call it a "tweak." It's a disaster. And thanks to all for avoiding the phrase, "Someday this war is going to end." Ooops.
But Tanta, with the demise of the FICO system now becoming readily apparent, shouldn't a lender attempt to renegotiate the terms to avoid the yawning chasm of cascading cross defaults implied in the race to the bottom that is developing.
More jingle mail means more REO, REO further actively depresses the market, leading to more jingle mail and more REO.
The problem is the disassociation of the end lender into ten tranches with different owners represented by some anonymous chicago trust that uses XYZ loan servicer.
Say my house is now worth 20% under what I owe- would it be in the lenders interest to modify the loan to pay a much lower rate of interest on the loan to forgo the potential losses associated with REO?
I would think so, but the phone call from the primary lender has come in yet suggesting a mod that would make economic sense.
In fighting the term "ruthless" and trying to substitute something else really implies criticism of the Chicago School of Rational Expectations. Fighting that in today's world is a losing battle. Did you know that research shows teaching undergraduates about rational expectations specifically strips out morality? Check out the literature regarding exposure to rational modeling and the outcomes from prisoner's dilemma in undergraduates.
We have encouraged folks to become sharks, so evincing surprise when they actually begin to follow the models should not be allowd.
Gary Becker is howling with laughter right now at this foolishness.
Someday this war's gonna end...
If a corporation defaults
These are not corporate loans. Price Stout is correct. The legal documents creating a residential mortgage loan do not make price of the payoff equal to the current value of the property. I don't know how many times I have to say this. You can, if you want, say that the terms of the mortgage loan can be described in options language. That does not mean that these are options contracts.
It means lenders mispriced the risk of no-down lending.
Clue me this.
A mortgage contract is not written as an explict "put" option, but isn't the risk spread premium suppose to account for that. If the load was 100% recourse (and collectable), shouldn't the interest rate be equivalent to the conforming rate?
Tanta,
As an aside, exhibit 2 was a great inclusion. A way to enhance it, to my mind, would be to plot the difference between the 10-year and the MBS as a single graph as a follow-up. It would, of course, look very much like the payoff diagram of an explicit equity put, which I think brings the point home.
Don't the GSEs & FHA make loans to people with foreclosures, once they've passed the 2-year mark?
Only with documented extenuating circumstances. In other words, only if it's "distress" instead of "put."
To that I say: Congress can --and, when sufficiently pressured, will-- change the rules of the game any time they see fit. There could potentially be millions of people walking way --regardless of whether it's a "distress" walk, or a "ruthless" walk.
How does the old saying go? If you're going to do something stupid, do it in large numbers.
Oh it happened before, but it will be MUCH different this time.
Jingle, Jingle....
http://bp3.blogger.com/_ym8Q9yxUg34/R59XZz2bdQI/AAAAAAAAB9M/eYUo5fAOgkA/s1600-h/csi11072peak.JPG
shouldn't a lender attempt to renegotiate the terms
Well, I've been arguing for the sense in workouts all year. Often to the howls of outrage of the "moral hazard" brigade, who have been telling me at length that a deal's a deal: you agreed to pay this much and you have to pay it.
On the whole, some of this (say, the hesitant-ruthless borrower) could be solved with lenders just getting over it and cramming themselves down.
Some of it can't be. I don't know if you've ever tried to negotiate with a truly ruthless borrower, but my experience is there's no point to it.
Some genies can't be put back into bottles.
"Some of it can't be. I don't know if you've ever tried to negotiate with a truly ruthless borrower, but my experience is there's no point to it."
Well, there is some value in not defaulting, even if you come out ahead vis-a-vis your current mortgage. Restricted access to credit going forward isn't cost-free, unless you're moving into a cave without electricity and becoming a subsistence farmer.
Alright, call me old-fashioned but I never paid much attention to the price of my house either during the boom or now during the bust. I bought a house I like and can COMFORTABLY AFFORD. It is not an ATM nor is it an investment-that is what I have stocks, bonds, CDs and a small business for. It's just my house, which I intend to continue living in unless dire circumstances (fire, flood, grave illness. etc.) force me out. If I wanted to invest in RE, which I don't, I would buy an apartment or commercial building.
Sheesh!
"These are not corporate loans."
I agree, but secured, non-recourse is secured, non-recourse. If I promise to pay regardless, then it seems beyond non-recourse. I must be missing something here. TIA.
The ruthless/dumb couple on 60 minutes were especially upset with the fact that they couldn't refinance but were stuck both upside down and with an 11% interest rate.
Being down $100k @ 6 percent, tax deductible is like an extra car payment.
They were 'dumb ruthless' -- not exactly a position I would like to find myself in.
Anyway, I still think most people with problems will be stressed or distressed -- not the cool, rational smart money that walks without any blowback. Like Donald Trump.
If the load was 100% recourse (and collectable), shouldn't the interest rate be equivalent to the conforming rate?
As long as you factor in the costs of collection.
There is the time value of money. That's actually why conforming GSE pools have some additional value to investors: the GSEs don't just guarantee "eventual" return of principal, they guarantee "timely" repayment of principal. The GSE (or servicer) advances principal to the investor, and then goes and collects it from the borrower. So if you own part of a GSE MBS, you don't have to account for it taking a year to get your hands on your principal in a default situation.
So yes, the GSEs have the pricing problem of setting the guarantee fee. But there's still the "call" issue with conforming vs. jumbo.
Tanta sayeth: Well, I've been arguing for the sense in workouts all year. Often to the howls of outrage of the "moral hazard" brigade, who have been telling me at length that a deal's a deal: you agreed to pay this much and you have to pay it.
This member doesn't see it that way. I've been arguing that a public willingness to do workouts will "create its own weather" and thus expand the pool of candidates for workouts. The hazard isn't in letting some FB "get away" with something. The hazard is to the system that becomes a larger problem by becoming an attractive nuisance.
I have agreed with you as the declines have accelerated that the need for mods is apparent. What is happening is the very disintermediated structure is putting the asset owners at cross purposes and not allowing even hesitant-ruthless borrowers (a class that I probably fit into) a chance to even begin to negotiate.
I think we will see outright capitulation by the mortgage first lienholder brigades with the heloc folks fighting a rear guard action that only delays the inevitable.
Meanwhile, a lot of folks that might have just held their noses and continued to make their payments are going to walk because they feel housepoor, and they see a large number of empty houses just sitting on the market in thier area with no progress in clearing the overhang.
That leads to the race to the bottom.
What reasonable thing can you tell an ARM holder facing reset that is now 15% underwater? Too bad, go away?
The sad part is that this bubble, unlike the last stock bubble, took in a whole bunch of folks that would have most likely in the next few years made it as homeowners and allowed the boomers some support to their fantasy of selling the old homestead and using the money for a trip to Bali.
Now, no dice.
I think a lot of the moral brigades understands that this will impact them as the real estate market will most likely not have another bubble in their lifetimes. That realization that real estate is over will be quite painfull in the coming decade, and will make an already angry polity even more grouchy.
Someday this war's gonna end...
aotc- Do you have a family that has MANY future $$ needs?
Tanta wrote
As far as I can see, they're just trying to reflate house prices.
To fix things, they don't need to merely reflate current prices in some way. They need to reflate appreciation rates, too, back up to bubble levels. The promise of future appreciation was the only thing supporting current prices.
I think if the villagers recognized that, even they would choke on it.
Tanta,
I'm going to send this post out to everyone I know (including analysts working both here in the U.S. and in India) who is working on their CFA. You summed up in about 10 pages what it takes Fibozzi's "Fixed Income Handbook" about 150 pages to do, and in a much more clear and understandable way. BRAVO
"...please take the time post a graph or table w/ price-to-income ratios for various Canadian cities."
Here's a link which
calculates the ratio of the median house price to the median household income for many cities in the U.S. and Canada.
I'm suspicious about the numbers for Vancouver, since they somehow come up with a median house value of $503,400, while the
Greater Vancouver Real Estate Board states that the value of a "detached" house is $732,320.
I couldn't find anywhere how the first study defined what a house is, but in Vancouver a house is detached, while an attached unit is a townhouse, and an apartment is a condominium.
"I think a lot of the moral brigades understands that this will impact them as the real estate market will most likely not have another bubble in their lifetimes. That realization that real estate is over will be quite painfull in the coming decade, and will make an already angry polity even more grouchy."
I am not sure what it would take to put a stake through the heart of the real estate investment thesis. I think most people would still say that housing will cost more in 5 years. Excluding ground zero in the current bubble. Not above the maximum prices but current prices.
Thanks Tanta very well written.
Ding! Ding!
Award to lessismore for being the first to say "efficient breach."
And Tanta is correct, bytheway, it IS a breach. Thus damage to future creditworthiness. But we don't drag people out behind the barn and shoot them for breaching a contract. Well, not so much anymore. Dirty rotten contract-breachers. Instead, we just gather what apples we may, based on the safety mechanisms built into the contract. Some lenders are learning that some borrowers price the results of breach differently than others.
Good times.
Your house is a consumer purchase not an investment. If you can afford it and you enjoy its use, then by all means, go ahead. If you want to invest for the future (as you should) than you need to acquire a share in what Marx called "the means of production". That can be stocks, investment real estate (i.e., cash-flow generating property), a business or anything that generates future cash flow.
The fact that so many misunderstood that is the root of the problem.
Rob, we are going to take our pain one way or another, so why not allow folks to keep their palace at a cheaper rate. One of the things I advocate for is simply cutting the interest rates waaay down. Then when the real estate market finally comes back the priciple will at least have a chance of being repaid.
These losses to principle through crappy recovery rates are far more devastating in terms of valuing pools than a lower interest rate would be.
That is how you deal with stranded borrowers, not by saying "Oh well, if we give you a deal, then everyone will want it."
Do the deal, and give them cheap interest rates, without changing the structure of the current loan in terms of refi's. Just do the mod and take less interest. Ruthless folks will prepay their mortgages, or they will just pay less and keep spending.
Either way we get what we need, a big slowdown in foreclosures and some economic stability.
The current course is madness, and will lead to a Js Jin paradise.
Rob, sometimes you just have to accept that the ruthless folks get out and win under the cover of the common man's disaster.
Casey showed that playing the game was darned near riskless in living well for a couple of years on OPM.
Someday this war's gonna end...
Alpha_Bear - That is a beautiful report...can also come in handy negotiating contract 'per diem'
You summed up in about 10 pages what it takes Fibozzi's "Fixed Income Handbook" about 150 pages to do, and in a much more clear and understandable way
My new motto: "I read Fibrozzi so you don't have to."
Actually, I didn't learn about mortgage pricing by reading Fibrozzi (useful as his text is, no question).
I learned about mortgage pricing after having been removed from my comfortable cubicle in credit policy and being escorted to my new cubicle in secondary marketing. As my boss said at the time, "Don't be intimidated. Your new colleagues have better math skills than you do, but since you're the only one in the room who actually knows what these "mortgage" thingies are we're trading, you have a distinct advantage."
Personally, I don't think people will give two shits whether or not you call this "ruthless", "fascist", or whatever for walking on underwater loans. This is the natural course of events when you get away from solid lending practice.
The banks and Republican ideology is at fault here. The banks and their people are largely at fault because of their ruthless pursuit of percentage. Bush and his minions (think Greenspan and Ayn Rand) took the controls off because that's exactly what they wanted to do. They wanted an economy where control was light to nonexistent, and this is the natural result of all that.
Over the past several years I've become very conservative about finances. I do feel that, if we went back to an educational system that stressed traditional classical education, people might have a more strategic view of these things, instead of the totally operational society we live in now.
Fat chance of that.
"If you mean as a matter of law (or fact), you are simply incorrect."
Thanks Price Stout.
If someone lives in a non-recourse location, doesn't the law effectively supercede the contract language? What is the homeowner really signing here?
I don't have a problem with the word "ruthless". Hell, I'm willing to bet that some traders on Wall Street would be honored if you called them ruthless
.
Instead of calling a person ruthless, I'd just say she is marking her house ( and mortgage ) to market. If the MTM of this portfolio is negative and she has a legal option to exit at zero then that sounds financially rational to me. It might be immoral, but it's hard to argue that it isn't rational.
The one thing people probably don't factor in is the cost going forward. Good luck when she tries to find cheap credit in the future.
It seems to me that the real problem here is a total pricing failure on the part of lenders. They priced the rates on their loans using irrational assumptions about the market. My friends in finance have many colourful phrases for this situation -- "quote the wrong price often enough and eventually someone will rip your face off". lol
my first comment here to congratulate Tanta on another truly outstanding post! thank you.
Whether termed ruthless or efficient breach, we are talking about breach of a contract which was based on both consideration and mutual assent. Accusing mortgage "sellers" of malfeasance ignores that in many cases the buyers were just as greedy. Not just greedy, but also savvy enough to understand concepts like "cash out", now "upside down" and "putting" (but not "ARM"?). IMHO, nevermind what they're selling, its what you're buying.
Alpha-Bear excellent find!
A key finding from the report that everyone should recognize:
Low affordability is driven by restrictions on building, not low interest rates or population growth. Many markets that grew very rapidly in population (Houston, Dallas, Ottawa) remained affordable.
Jingle mail is not an efficient breach of contract.
In an "efficient breach," you have to make whole the party to whom you broke your promise.
Lenders are not being made whole when people walk away from loans larger than the value of the security--by definition!
Oh Tanta:
That thinking is so Old school, Bill Clinton era stuff. Remember the new mantra, Yes We Can...Change (and exercise that put!)
I wonder what Uncle Sam would think of all this. Wouldn't the ruthless borrower owe the IRS for his ruthlessly taken forgiven loan? Would the IRS pursue payment eventually even tho lender would not?
AllenM writes:
Rob, we are going to take our pain one way or another, so why not allow folks to keep their palace at a cheaper rate.
You mean my palace. Seriously, it isn't theirs and never was and now never will be. We cannot choose to reverse discriminate on the basis of financial acumen lest we become Harrison Bergerons and all devolve to the lowest common denominator.
Sorry, gravity seems somewhat higher today.
Come on aotc...are you recommending construction in the ocean off CA & FL, now? You are truely going over the 'deep' end now.
I'm really starting to wonder if you have ever recently been to any of these states or even Texas, at all. Get a grip.
While we're on the subject of workouts, here, let me note that this is why I opined a few weeks ago that you can't get very far trying to do a short sale with a truly ruthless borrower.
If the borrower truly doesn't care what your loss is, the borrower will try to sell the house for $10 to his brother-in-law Verne without a real estate broker to "eat fees."
That's why, whenever you as a servicer are presented with a short sale proposal, you have to slog through the process of verifying that it was an arm's-length deal and the sales price is the best the market will bear. Otherwise all you're doing is making the put that much cheaper.
Anonymous-I have been to all of those states. I suggest you READ the report. Affordable housing can be built anywhere. The reason it is not is that existing homeowneres don't want "those people' living near them so they enact minimum lot sizes, restrictions on sub-dividing and on and on. No place in the US grew faster than Texas in the 80s and yet Houston and Dallas are 2 of the most affordable cities anywhere. Even New York is considerably more affordable than LA, SF or San Diego. Now why do you think that is? Think high rises vs endless tracts of single-family houses.
Marcus I don't do collections but imo with respect to the judges I practice before they aren't going to let you garnish wages unless you provide them with sufficient facts for them to conclude it won't be detrimental to the deadbeat's dependents. A judgment is no problem but actually leaving a family with no funds? All it takes is one ugly case to hit the papers and the judge is in a world of hurt ... no upside whatsoever for him to grant the requested relief ... generally here in florida you don't sue at all unless there is an insurance company that can pay the damages (unless you are going after really deep pockets) ... never heard of a personal injury lawyer turning down policy limit ... I see this a lot in probate cases where MBNA got a judgment against the deceased, they never actually try to collect the judgment through court action cause no judge in the world is going to garnish a little old lady.
Actually, I didn't learn about mortgage pricing by reading Fibrozzi (useful as his text is, no question).
you mean Fabozzi? or is there a joke there i'm not getting?
One easy way of seeing that even a non-recourse mortgage is not a put option is looking on the credit report. Excersing puts doesn't leave black marks on the credit report, foreclosures and short sales do.
aotc- WHAT? Miami had/has plenty of high rises, remember?
But somehow the financial Ponzi Scheme had NOTHING to do with that or the 50%+ price haircut we are now seeing.
Sheesh! is right.
I forgot, never argue with a ____.
you mean Fabozzi?
Yep. I must stop typing with my nose.
There might have been a joke if I had said "Fibonacci."
I don't exactly know what the joke would have been, either, but it would have been pretty funny.
"a non-recourse mortgage is not a put option is looking on the credit report."
The ding on the credit report is part of the premium...
Read the g##d### report. Here it is again.
calculates the ratio of the median house price to the median household income
I didn't say the financing had nothing to do with it. It was necessary to enable prices to get so high. Nevertheless, financing was not sufficient. Land restrictions were essential. Car companies have 0% financing all the time, yet car prices don't go up to the sky. Why? Because they build as many cars as people want to buy.
yes, it would have been funny. probably something to do with a spiral and a pig's tail.
by the way, that's one lazy Pig. he's been in that pool for ages.
yes, it would have been funny. probably something to do with a spiral and a pig's tail.
Fibonacci:
1. Mathematitian
2. Spiral-shaped pasta-like dry food, derived from the tail of financial pigs
The ding on the credit report is part of the premium...
The premium is supposed to go to the writer of the put.
Anyone who thinks jingle mail is "part of the deal" with a mortgage will find out otherwise as soon as he tries to get another one.
For a while, perhaps. But the thing about ruthless self-interested people is that they're very predictable and easy to deal with. Write the contract so it's in their interest to keep following it. And that's very easy with mortgages - 20% down and stay away from bubble markets. If the banks haven't figured this out in a few years I see a great business opportunity. And for the next few years if they're prevented from buying it will be to their benefit.
Mathematitian
A numbers geek who can also paint nekkid women?
Typos are like yawning. One person starts it, then we all get it . . .
example:
The Fibbonacci numbers are smaller than the number of Fibbonaccis on this plate. Let us therefore start eating. "Lord thank you for this mortgage pig, we shall not draw your pig in vein and we shall not make Fibbonaccis out of him or his family without prior blessing. The fibbonaccis shall be contained (in a container)".
"Markel writes: Jingle mail is not an efficient breach of contract. In an "efficient breach," you have to make whole the party to whom you broke your promise...."
I was wondering if someone was going to make that argument. Generally, your statement is correct, but I wonder if the fact that the lender appraised the property BEFORE making the loan affects the analysis. In other words, the lender did not simply review the buyer's financials and FICO in order to assess the risk of default, but also evaluated the property itself to ensure that the loan was adequately secured. That seems to shift some of the risk of lower property values to the lender, or at a minimum, the lender recognizes its exposure to the risk of default when the LTV is greater than 100%. Otherwise, why would the lender bother with the appraisal in the first place?
That strikes me as significant. Both the borrower and the lender are making an informed bet (based on property appraisals) that the property value will not drop below the loan value. If the lender has a gripe, it probably should be with its appraiser. But the news is replete with appraisers claiming that the lenders encouraged high appraisals in order to make loans. All of which makes me think that the lender did get paid for the implied "put" option - the fees it received for making the loan. Unfortunately for the lender, it simply undervalued the risk of default viz. those fees, and instead should have charged more fees or higher interest.
aotc,
I notice sizzling Scranton is also quite affordable, in spite of suffering from that Northern affliction of zoning.
I also note that the study seems to avoid macroeconomic explanations for any housing affordability issues.
Zoning in the USA is not the story behind rising house prices.
Further, I note that many of the places that have implicit affordability have extremely high property taxes due to declining macroeconomic conditions.
Um, same sized house in similar neighborhoods in Phoenix and Dallas yields a difference of 50% cheaper property taxes in Phoenix, even for a house priced at twice the price in Dallas.
The problem is that if a house is worth X dollars, but the property tax is twice what house Y is worth, that differential in property taxes is reflected in the price.
Property taxes are a huge drag on property prices, and Prop 13 illusions of affordability are part of the problem, not the solution. Geez, Rob do some 'splaining 'bout mello roos..
Someday this war's gonna end...
Someday this war's gonna end...
A numbers geek who can also paint nekkid women?
throws a tomatoe at her
Mathematitian
A numbers geek who can also paint nekkid women?
OMG a 3-level opportunistic pun! You're incredible, Tanta.
All of which makes me think that the lender did get paid for the implied "put" option - the fees it received for making the loan.
You're absolutely right, and that is in fact my point about why non-recourse laws exist. Their purpose is (supposed to be) to force lenders to get real with those appraisals and down payment requirements in the first place. They just didn't have the correct inhibiting effect because investors drank the koolaid about endless appreciation.
About the pricing, the lender might have gotten paid for the loan, but the investor didn't get paid for that "put." Or, to be more precise, did not require to be paid for that put. In other words, investors did not adjust their options analysis model to take into account the fact that a historically unprecedented lending practice (no down based solely on a FICO) would create "puts" where there did not used to be "puts."
AllenM- Don't feed the troll
Anon, I don't think Aheadofthecurve is a troll.
He/she is, however, someone who does allow disagreement to get a bit heated. Ahem. Both of you.
--
Breaking News...
14 companies under criminal investigation by FBI for sub-prime fraud.
Jas
Thanks a lot Tanta for your excellent explanation.
Supreme!
"The premium is supposed to go to the writer of the put."
It's a non-cash premium.
Tanta,
Can you help me out regarding this moral/ruthless/deal topic?
Price Stout's post was interesting. What is the typical homeowner signing? If the law prevents recourse, but the homeowner promises to pay regardless, what does that mean?
Is the CFO that walks ruthless, efficient, or something else. Perhaps I'm attempting to draw a parallel that shouldn't be drawn?
One of my degrees is in finance and I scored highest on the CFA ethics section. This has to be a difficult dilemma for the average homeowner facing foreclosure.
they aren't going to let you garnish wages unless you provide them with sufficient facts for them to conclude it won't be detrimental to the deadbeat's dependents.
Yep and the precentage of income the lender gets in garnishment is actually quite low on mere unsecured debts (in my state anyway YMMV).
Not to mention the time and process of hiring a local attorney, serving the debtor and actually getting into court since they are so clogged with criminal cases anyway and those get priority - lenders trying to get before a judge may have a long wait ahead of them on a deteriorating property on which they may be liable for property tax.
Tanta- Sorry....not much else happening today I suppose.
Just think, if the # sign was actually a direct voice link to the poster, that could really shorten some of these threads by taking 'heated' posts off-line
And, if we just fed the mayonnase to the tuna...
It's a non-cash premium
It's a non-cash premium being paid to somebody other than the writer of the put. What am I, the original lender, supposed to do with your new credit report problem? Feel vindicated? That's not a option fee.
You pay a put premium when you buy the put, not when you exercise it. If you don't exercise it, you don't get the fee back. Right?
Look, all "recourse" means is that the lender (may) have recourse to other assets of yours besides the house in some cases of default.
But of course lenders don't want to go to court to get at your jetski. They don't want to own your home, either.
Maybe it will help you to remember that mortgage pricing is about valuing a cash flow. If we have to start pricing mortgages assuming that we get a non-negligible amount of our principal back by long expensive legal recovery means, then we will do that. That means mortgage rates/fees will go up.
And they will go up for everyone, because you cannot by definition "find" a ruthless borrower in any pool that allows no-down offset by a high FICO.
Or, we can eliminate no-down and demand realistic appraisals. That will fix the ruthless borrower problem because that means the borrower has "skin in the game."
What we will not do is continue to offer no-down financing at the same cheap rates. Because they result in too many "puts."
I assure you I am not a troll. Remember it was Alpha_Bear who found this report, not I. I apologize for getting annoyed, though.
Allen- There certainly are places like Scranton or Buffalo that have experienced such population loss that it is virtually impossible for prices to have risen. Nevertheless, some places with little population growth (Boston) have had huge price rises and others with very rapid growth (Dallas, Houston, Charlotte) have remained affordable. Why is that?
You are correct that taxes are a component of housing costs. Nevertheless, I submit to you that if you included property taxes, the relative standings of these cities would not change much. LA, SF and SD would still be enormously unaffordable, despite their not having grown all that rapidly in recent years.
I'm not letting the banks off the hook. But we all have some blame. If your neighbour decided to create affordable housing by renting out rooms or allowing 3 houses to be built on their lot, would you be at the next city council meeting complaining? I suspect many of us would at least be thinking about it.
like is a "covered call" is wearing clothes and a "naked put" is when you are undressed and... just...(ok i wont go there)
I think a good working definition of an ubernerd is someone who gets more excited about naked puts than naked bodies
HARM writes: (01.29.08 - 2:06 pm)
When the banksters and so-called "regulators" start modeling "ethical" behavior as a matter of course, I'll change my tune.
I am sure the modelers have estimates of the "ethicality" of the borrowers (what Tanta would term "lack-of-ruthlessness") in their models. Much of the hand-wringing right now is due to the (completely unforseeable!) fact that their estimates, when applied to average Americans, were either way off-the-mark, or have changed dramatically.
This might be old news, but Tanta did you see the pink pig sidebar advertisement? Pink pigs must be all the rage now.
"lack-of-ruthlessness"
That would be ruthful.
That would be ruthful.
I like "ruthiness."
Much of the hand-wringing right now is due to the (completely unforseeable!) fact that their estimates, when applied to average Americans, were either way off-the-mark, or have changed dramatically
It is, ultimately, about failing to account for moral hazard. We "over-insured" these folks and they are acting exactly the way theory predicts they would.
Pink pig advertisement screen capture:
http://bp3.blogger.com/_zqzPMzXNGso/R5-Xcddl8FI/AAAAAAAABWQ/ekEENT8HXeE/s1600-h/Picture+2.png
Must be Mortimer since he has no lipstick and thus cannot be Morticia.
Houston and Dallas in the 80's experienced a tremendous crash in real estate that overshadowed the market there for at least a decade, if not realistically until today. That was an income crash for an entire region- LA has not had a significant income crash since the last housing crisis in the early 90s, and still has a significant advantage in earnings for the entire areas.
Denver is another market that did not experience the huge run up in pricing that the coast did.
I am not arguing that there are not valid reasons why there are huge pricing differentials, but that article mainly is about pricing versus income. Places with significantly higher property taxes versus places with lower taxes but with similar incomes will show the differential most markedly. Texas is well studied in the economic literature with regard to the housing pricing differential due to the lack of income taxes. By putting the incidence of the tax onto the property owners, lower real estate prices have resulted in the choice of the tax structure and the choice of wealth accumulation.
Building more houses is not the solution when you have had a housing bust, and removing zoning to allow renting out McMansions as apartments will not help out the owners of neighboring properties. If anything, the history of the relaxation of housing into lower class transient housing in the urban east should demonstrate to you that zoning has value. Ever seen an entire row of what had been mansions in the 1890s-1920s turned into cheeseball apartments? It exists back east in spades.
The problem wouldn't be solved by building more housing that is more affordable- they just did that in California, and I note that the new affordable housing is where the property crisis is concentrated.
Lack of earnings to support the prices is the issue, not zoning restrictions in Newport Beach.
Sorry to preach, but sometimes the Cato Institute stuff really bugs the crap outta me.
Someday this war's gonna end...
"I am sure the modelers have estimates of the "ethicality" of the borrowers (what Tanta would term "lack-of-ruthlessness") in their models."
Not precisely. You can't know what lurks in the heart of man, after all. As far as consumer default-risk models go, though, they routinely capture "stability" attributes like time-at-residence and time-at-employment, etc. These aren't markers for ethics, though, they're more indicators of "skin in the game" with regards to tenure, neighborhood/local links, etc. In other words, they indicate that the borrower does not intend to fly-by-night at the first whiff of trouble.
Tanta,
Enjoyed the post, excellent work. What it seems you are saying is threefold. first, there is no put option in a mortgage contract, therefore, anyone that "puts" the asset back to the mortgagor is acting immorally and third, if ever a put were to be included in a mortgage contract it would be impossible to price.
On the moral issue, I have the answer. Ayn Rand apparently says that there is no collective responsibility, that it is moral that individuals act always in their own self interest. Also, capitalism is the only "morally correct" system. On this basis, walking away is a moral thing to do, isn't it? If the basis of the idea that "what's good for business is good for America" is that business gets a free pass on moral issues and if we add Rand's philosophy that Capitalism is by its nature morally good, then nothing that either the banks or the individual lender does can be construed as immoral, can it? I suppose I mean that what's "morally acceptable" for the upper classes is eventually morally acceptable for everyone is an age old truism that has bitten us on the ass time and again throughout history.
Now onto the banks/hedgies etc. I fully believe that there is no explicit put option in mortgage contracts and that there is an explicit call option (I checked my own 15 yr mortgage on a house upstate). The problem is that the mortgagors are also acting in a sociopath manner to avoid their responsibilities. They set up a financing model whereby profits were generated by fees and they then used a plainly bogus set of information to pass on the risk of the mortgages they wrote. They have as a group, both in morgage financing and in consumer credit generally, acted to purposely target the most vulnerable by structuring contracts that were impossible to hoinor to maturity and then overlaid fees, penalties etc to generate a return to the extent that, even when a debtor eventually defaulted, they would offer another card/mortgage/line of credit almost immediately after default to begin the merry-go-round again.
Now these banks have created a culture of default without obvious penalty and now it is time to pay the piper. But again, these financiers are acting ina truly Randian fashion, by refusing to acknowledge the extortionate relationship they have with both investors and customers and insisting that the taxpayer take on the cost of their own actions over a number of decades.
I think the idea that any system must be assumed to be "moral" is already dangerously repugnant, but there it is. You reap as you sow.
Speaking of crap bugging me:
""The sooner we get this relief in the hands of the American people, the sooner they can begin to do their job of being good consumers," Boehner said.
Expired
More bongwater.
Someday this war's gonna end...
The cash premium is supposed to be reflected in the interest rate.
I'm still confused as to why the homeowner shouldn't take a commercial world approach...My conclusion is that if I live in a non-recourse location, I have a mortgage, and an earthquake levels my house, I'm going to walk. If asked, I would tell the lender on my next mortgage that I would absolutely do the same. My presumption is that this is rational behavior that should be reflected in the interest rate. That's my understanding of the deal.
"Tanta writes: In other words, investors did not adjust their options analysis model to take into account the fact that a historically unprecedented lending practice (no down based solely on a FICO) would create 'puts' where there did not used to be 'puts.'"
If I understand your post and your subsequent comments, you are trying to describe the current situation (positive analysis) rather than evaluate it (normative). If that's the case, I agree with you.
But I think the rubber hits the road when you label the borrowers "ruthless." Can't we just as easily label the lenders "ruthless" for engaging in these loan practices, at the expense of investors? Isn't making these loans in the first place just as ruthless as strategically defaulting on them? Your post concludes with various ways to avoid ruthless defaults. Do you have any recommendations for avoiding ruthless lending? What should the investors do to bring lenders back in line?
OK, so what does this mean going forward? Will the mgt. bailout inflate that housing market? The refi mgt? The credit bubble?
You want ruthless? My friend did a refi, monthly payment $1500. Total yearly pay down on the mgt. $33.00.
Not that is ruthless. This is a debt based economy.
The cash premium is supposed to be reflected in the interest rate.
Yes.
But it has not been. You may, for instance, understand "teaser" rates on ARMs as a failure to front-load the option cost.
Every lender knows every borrower would "walk" (or be forced to walk, since you have to find shelter) if the home were destroyed. That's why we force you all to insure it.
You are welcome to get commercial loan terms. I for one have advocated for a long time that all investment property loans should be in the commercial portfolio, not the resi 1-4. The only reason they aren't is that Congress considers there to be some "social good" in basically offering subsidized interest rates to small-time RE investors.
So we're in agreement here. If you want to speculate, you will pay a higher interest rate on your mortgage loan. Unless Congress intervenes to artificially lower the cost of speculative mortgage credit by taking it all the in FHA program.
ella wrote
"OK, so what does this mean going forward? Will the mgt. bailout inflate that housing market? The refi mgt? The credit bubble?"
None of the above, the piranhas are now looking for new meat to devour because the consumers' bones are picked clean. They want to clean their balance sheets by transferring all of the sewage onto the taxpayer so they can free themselves up to pump the next bubble (emerging markets credits/commodities, whatever will react to easy, extortionate money). Mortgage financing/securitization is dead for at least 10 years, or until a new generation comes along without direct experience of all the BS that went on this time around.
Tanta:
Thank you for the explanation. I'm pretty clear on human behaviors but the aspects of convexity and such were foggy.
Excellent post.
" They want to clean their balance sheets by transferring all of the sewage onto the taxpayer..."
Would that be the banks dumping it onto the taxpayer via refi's. sold to the GSE?
"Would that be the banks dumping it onto the taxpayer via refi's. sold to the GSE?"
that's an interim step. the second one of that is for the federal government to explicitly assume the debt through the recapitalization of the GSE's or by taking on the toxic waste directly into a federally sponsored fund. another way is to have the fed buy the MBS paper from the banks at a price that is higher than the market price (already happening), but when the time comes for the banks to retake possession of this paper at that value plus interest, the banks refuse to honor the contract (not happened yet).
Can't we just as easily label the lenders "ruthless" for engaging in these loan practices, at the expense of investors?
Look, I didn't make up the term "ruthless." I guess I should have made that clear. Do some Googling, if you like.
We can decide to call them something else, if "ruthless" upsets everyone so much. But I will insist that you have to be wary of the "fig leaf" effect.
As it happens, I have labeled mortgage lenders "sociopaths" (UberRuthless, if you will) so many times in posts on this blog in the last year that I have lost count. I just didn't do it in this particular post.
My proposal is in the last paragraph. Require reasonable down payments, get real about appraisals, and forget about just shoving the problem onto the taxpayers via FHA. Get used to everyone paying a little more for mortgage credit in exchange for a less lethal RE market.
I have no problem with the idea that investors have to take the hit for having written puts they didn't price correctly. But the U.S. Senate is not currently working on a bill that requires MBS investors to take it in the bottom line. They're working on a bill that tries to bring back the punch bowl.
"unprecedented lending practice (no down based solely on a FICO) would create "puts" where there did not used to be "puts.""
One could view a non-recourse loan as call option on the asset. The premium is your interest payment. The strike price is the purchase price minus the initial equity or money down.
Look, I didn't make up the term "ruthless."
that's true. it's even used in Fibonacci's book a number of times.
"My proposal is in the last paragraph. Require reasonable down payments, get real about appraisals, and forget about just shoving the problem onto the taxpayers via FHA. Get used to everyone paying a little more for mortgage credit in exchange for a less lethal RE market."
I can certainly drink to that! Thanks Tanta.
'Dirk van Dijk writes:
like is a "covered call" is wearing clothes and a "naked put" is when you are undressed and... just...(ok i wont go there)
I think a good working definition of an ubernerd is someone who gets more excited about naked puts than naked bodies"
Actually Dirk a naked put and a covered call are synthetically equivalent...
I understand the following to be a put-option:
Non-recourse loans include typical California purchase loans used to buy an owner occupied residence of up to 4 units.
State Law protects borrowers from personal liability on a purchase mortgage for a home which they occupy at purchase. (If the borrower later converts the home to rental, he is still protected.) The State has put the risk on the lender; the most a lender can do is take back the house. This law applies to properties of up to 4 units, and applies only to loans used to purchase the property.
Purchase loans include bank loans and seller carrybacks.
This applies to JUDICIAL FORECLOSURE as well as A TRUSTEE'S SALE. So in California you can walk away without any personal liability. Which should keep lenders from making silly business.
"That's why we force you all to insure it."
But you don't! I don't know anyone with earthquake insurance in Cali. It's too expensive.
Writing of ruthless, I've actually contemplated obtaining a mortgage for the sole purpose of limiting my risk.
Ella writes:
"'The Senate plan does not include the proposal by the House to increase the limits on conforming mortgages that can be bought by Fannie Mae and Freddie Mac, or insured by the Federal Housing Administration.'
That is an odd twist."
There was a blog post just a few days ago saying the people who trade the securities the GSEs issue don't want them buying jumbo loans since its messes up their models.
AllenM writes: Speaking of crap bugging me...
I quake and quiver inside whenever I hear anyone start talking about how they're going to help me do anything with my "hard-earned" dollars. Somehow, their help always seems to involve getting my government deeper in hock to China.
(Whoops, now we're WAY OT, and I ain't talking "Operating Thetan"...)
Allen C: I'm still confused as to why the homeowner shouldn't take a commercial world approach...
Because, IOKIYAC. (It's Okay If You Are A Corporation.)
Clearly, the solution is to self-incorporate.
Couldn't the lenders go after 'high profile' ruthless defaulters?
There must be Politicians or CEO's or other community leaders underwater and looking for the easy way out by jingle mail.
And the news coverage generated by the lenders pursuing them may cause some who have the capability to pay to reconsider jingle mail.
(Ziggurat above said it first)
per Wikipedia: "Even though FHA is statutorily required to be budget neutral, the GAO is projecting taxpayer funded subsidies of half a billion dollars over the next three years, if no changes are made to the FHA program... [though] new budget numbers are projecting "windfall revenues" for FHA due to the collapse of the subprime market and a flood of new loans being originated with FHA."
Any thoughts Tanta to FHA increasing their fees to live up to their budget-neutral mandate?
Allen M-Your arguments are reasonable. And it is certainly not the time for measures to liberalize building restrictions to lower prices. Still, I think it takes more than low interest rates to drive prices up. Goods where supplies are elastic (cars, computers, golden retrievers) will not shoot through the roof, no matter what Greenspan and Bernanke do. It requires highly inelastic supply constraints as well.
By the way, if some poor slob can only keep his house by letting out rooms to college students, I'm not sure the law should forbid that, provided fire and safety codes are abided by.
But this thread is getting long...
Bye
ya...this is a great idea....now a person will have to get an economics and law degree to figure out how to own a condo.
now a person will have to get an economics and law degree to figure out how to own a condo
Well, since the whole point of owning a condo is to not have to figure out how to start a lawnmower or clean out gutters, surely you've got some extra free time there . . .
Mortgage U!!!
2thumbsup:-)
Gawd, this is interesting stuff!
Tanta, did you used to be an english teacher?
Reminds me of some papers I had to write that were supposed to be at least so many pages, but the topic could have been completely covered in 1 paragraph.
Aheadofthecurve writes:
"If you want to invest for the future (as you should) than you need to acquire a share in what Marx called "the means of production".
So AHC, tell me, given that you spend all day posting on this blog, just what are you producing?
Like most sociopaths, they dont understand why ruthless would be considered insulting or what this term social acceptability might mean.
Tanta, I resemble that remark. One may not actually be a sociopath; he might simply have an MBA. Although, I suppose, judging by actions there is very little difference.
Oh, I forgot to say. Fabulous post, if feedback from some anonymous dude on the internet means anything to you. Explaining convexity to civilians would make my knees tremble and not in a good way. Very well done.
Tanta, did you used to be an english teacher?
i believe Tanta's progression is: high school Latin geek, English major, mortgage geek/Excel Artist, master blogger/mortgage geek/Excel Artist.
there's no accounting for someone like that.
Some appear to argue that corporations can default on legal obligations or breach contracts at will with no adverse consequences, so why not individuals. I don't think that corporations find such/defaults breaches that simple or cost free.
If people decide it is fine to borrow someone's money and decide they have no moral or legal obligation to pay it back, they should not be surprised to find that credit becomes either unavailable or very expensive.
Of course this apply as well to innocents who made no such conclusion.
Just as they misjudged the advisability and cost of borrowing too much to buy an asset inflating in a bubble, the "ruthless" should not be surprised if it turns out that they misjudged the advisability and cost of exercising a "put" that they did not pay for.
plus i think i remember she had to walk uphill in the snow to school in barefeet...both ways!
"So AHC, tell me, given that you spend all day posting on this blog, just what are you producing?"
I run a very large escort service. My escorts mostly work at night. As for the product, I will leave that to your imagination.
Tanta- That wasn't me @ 6:23 (ahem)
I do find it odd people get upset by "ruthless". Would they feel more comfortable with the term "pitiless"? If I were in the situation,oh yeah, I'd be ruthless. But then, I've got way too many points in common with sociopaths (except I've got more friends). I see the danger to the fabric of society, but then, I see similar dangers all around, consumerism, the cult of personality, and anything on "reality TV". I see so many problems I don't know which to be most afraid of!
But as a relatively ruthless bargainer, I do understand that I'll do better in the long run by considering the situation of my counterparty.
Back on track- I'm not afraid of the government proposed solutions, they're not going to make that much difference and we will get back to the rational way of loaning money: as if it were your own.
bacon dreamz writes:
plus i think i remember she had to walk uphill in the snow to school in barefeet...both ways!
Didn't she have some sort of oppossum sled?
I didn't make up the term "ruthless"
No, but you're using it, and it is pejorative.
I call someone an "asshole." Then say, "Hey, no offense. I didn't make up the term 'asshole'."
I would say that people who walk on non-recourse mortgages are ethical, non-sociopaths.
Ethically, morally, and legally, an individual has a greater responsibility to her family than to a bank. If she can get a better deal for her family by stiffing the bank, she should.
The promissary note she signed said, "Binding under the laws of state XX" Well, if state XX is non-recourse, then the ability to walk away IS PART OF THE CONTRACT, whether the bank (or Tanta) likes it or not.
Sociopathic would be unnecessarily sending money to a banking institution instead of using it for one's family. An individual's fudiciary duty is to the family, not the bank.
look, "ruthless" is just the way this behavior is described in the industry. here's an example:
http://www.fanniemaefoundation.org/programs/jhr/pdf/jhr_0602_vandell.pdf
Whooof, sorry about the ad hominem.
Got a little worked up there.
Bacon - thanks for the link, but what does this mean?
Like most sociopaths, they dont understand why ruthless would be considered insulting
I would say, yeah, it's industry jargon, and it's also insulting.
BD - from your link, the first use of "ruthless" in this context was only in 1984. Mortgages have been around for centuries, and defaults are as old as mortgages. So what was it called before 1984? It's not like the Foster and Van Order paper forced us to use the term.
I run a very large escort service. My escorts mostly work at night. As for the product, I will leave that to your imagination.
Aheadofthecurve | 01.29.08 - 7:06 pm
I don't need my imagination, my point was we all have our own forms of ruthlessness, yours apparently being the use of research funds to pay your salary while you post on this blog all day.
"That leads us to the impending horror of the GSEs preparing to be the repurchaser of last resort.
Thank you Tanta for this most illuminating OberUberNerd Monograph (not to be confused with a monoline)."
Rob Dawg
You're right, Rob, and trust me: It will be ugly!
Tanta sez: Of course this behavior is "ruthless." For many people it's quite rational, but default is default. My whole point was that people are looking for reasons to escape the term "ruthless."
I don't buy this. They're looking to escape the possibility, that they're unaware of, of being labeled with the term "ruthless," which if I understand you correctly, is your pet term for this behavior? Gee, and here I thought that they were just trying to stop putting money into a sinking ship because they judged it worse than the resulting stain in the credit reports.
I think the psychological therapy tone of this whole post is just silly. Lenders have been pricing their loans irrationally, based on the assumption that the borrowers will also act irrationally by hanging on to an upside-down debt that either (a) the law says they can't be forced to hold on to (non-recourse), or (b) the lenders don't intend to pursue the borrower for (unwillingness to pursue judicial foreclosure when available).
There is no law of nature that says that thou shalt not default on your loans. You always have the option (in the everyday sense) to do so, and you have always have had that option. The consequences of exercising that option (pun not fully intended) are spelled out by law.
Any notion that there's a moral duty to pay your debts beyond what's required by law is simply a way to intimidate borrowers into acting irrationally so that lenders may make that much more money out of them. Why shouldn't it be the other way around? Why shouldn't it be the moral duty of lenders to forgive debt when they're in a position to do so? Why shouldn't it be lenders who aim to maximize their earnings that earn the label of "ruthless"?
Corporations were invented, and not recently either, to promote enterprenureship by eliminating personal liability, such that all you would lose in a failed enterprise was was you put in. That can be counteracted by a personal guaranty. Banks ALWAYS demand personal guaranties in the case of loans to small businesses, and that usually means that the wife signs too.
In the 80s, and 70s too, I heard a lot about equity kickers, and shared appreciation. So the lender would get a slice of the pie if prices went up. I see nothing wrong with that, if the lender let the borrower walk if things went sour. Not sure there is a legal framework for it, but see nothing inherently wrong with it either.
Mrs Ruthless 60 minutes wouldn't like that at all tho.!!!
Wonderful stuff. Sorry you had to get sick to add to this wonderful blog, but perhaps it is like Machievelli being kicked out of Venice? Florence? Or Galileo being put under house arrest. They did their best work once they were out of the heat of the fray.
thanks tanta.
thats good stuff.
If homeowners deserve to break their contract, then why not banks? I propose letting banks break the contract too, at any time by giving banks a free call, where they can obtain ownership of the house by paying off the owner with any accumulated equity.
Of course, once the owner has a free put and the bank a free call, isn't that the same as renting --- any accumulated rise or fall in prices goes to the bank?
Just because we as a society are willing to offer people a second chance if they break their promises through mistakes, that doesn't make it morally or ethically right to ruthlessly break ones promises. Those who do, I'll make sure please tell me so I'll know to never trust.
I agree with Tanta. Rationalizing the situation away is rationalizing.
i sincerely wish i had the time to read all these posts.
1) allenM - you may be one of the wisest, well-positioned people i've come across on the intertubes. you and dryfly and can duke it out for the title of 'nyah nyah nyah' at some point, and yet do it with humility. its reassuring.
2) tanta - this, again, is excellent stuff and i learned a ton reading it even as i've traded convexity in the past in my fixed income hedgie days
3) nothing. and i mean nothing, is as GOOD or BAD as it seems.
4) making projections about financial stuff is about as accurate as weather predictions. constantly refine, constantly revise, and constantly make proclamations.
that last #4 is probably my most astute comment ever on CR and it'll be buried under the weight of a 300 comment thread, but nonetheless there it is people!
This is a wonderful thread!
It reminds me of discussions that a teacher from years ago used to bait students into (high school teacher). The question is: it is the last 2 minutes of the basketball game and you are playing on the losing team. To get the ball back, you foul an opposing player. Is this ethical?
Is a 'foul' unethical because it is a violation of the rules? Or is the foul and subsequent punishment all part of the rules so that it is ethical to foul as long as you accept the consequences?
The discussions were very emotional.
Is a 'foul' unethical because it is a violation of the rules?
After watching twenty minutes of NBA basketball in the 'last two minutes' I can't imagine why even a high school student wouldn't realize that it's the strategy. Obviously, pre-Hack a Shaq.
Here's what mortgage brokers understand about convexivity
Mortgage Grapevine: East Coast VS West Coast Pricing????? Why the HUGE difference?
East Coast is whack?
quartz said: Some appear to argue that corporations can default on legal obligations or breach contracts at will with no adverse consequences, so why not individuals. I don't think that corporations find such/defaults breaches that simple or cost free.
Um, or perhaps you're just not reading these people's arguments well enough or charitably enough.
The precise nature of people's and corporation's obligations to pay their loans, whether a contract exists at all between two parties, exactly what obligations are created by the contract, and what consequences follow from breaching them, are matters of law.
I can understand arguments on moral grounds that the law is inadequate. I can even understand arguments that there are moral problems that the law has little power to fix. What I can't understand is the expectation of a lot of people here that a borrower should voluntarily bear the consequences of a financial burden that, either by law (non-recourse) or by the lender's choice (to not seek judiciary recourse), the borrower does not have to bear.
If the lenders mispriced their product, they don't get to bully the borrowers into keeping the cash flowing by calling them names.
Tanta...I just left a small tip for you all....anybody that can explain pricing of MBS and in the same document try to explain "ruthless" puts is a hero in my books.
I found your entry to be very thought provoking...I only hope the political types try to understand 5% of what you are trying to explain before they run off and try to solve our mortgage mess......
East Coast is whack?
Thanks, Stinky, that was hilarious.
We're all whack now.
all this talk of nekkid women makes me long for the days when I surfed for p0rn instead of watching this slow motion train wreck.
What is FB???
Every time I think I have that figured out I see it used in a context that assures me I dont.
oops in my previous post i meant Allen C not Allen M
but when C= Cash and M = Money - its all the same!
rom30
would say that FB generally means, "fu$ked borrower"
a sudden desire to understand just how I got where i am, and what forces are at work brought me to CR. Fantastic post Tanta, thank you.
ill take the ruthless brand, not because i am a sociopath, but because the kettle knows what color it is. and also because i know Socio the CEO is equally ruthless.
dc1000 - tks
Thanks.
A couple of points:
1) Trolliness is in the eye of the beholder. Greasemonkey and Killfile do a wonderful job of letting each person decide who they want to hide under a bridge.
2) A critical point about MBS pricing that may have been mentioned but I might have missed.
People who price mortgage-backed securities have always known that the prepayment behavior of mortgage loans is impacted not just by prevailing interest rates, but also by the borrowers creditworthiness, the lenders risk appetites, and the cost (time and money) of the refinance transaction.
It should also be mentioned that prepayment behavior is interest rate path dependent. This simply means that prepayment activity will be faster in scenario 1 than 2:
scenario 1) rates go from 9% to 8% to 6%
scenario 2) rates go from 6% to 8% to 6%
We are currently in a situation that resembles scenario 1. As such, most able borrowers already refied when rates were crazy-low a couple of years ago.
Thanks again.
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Does anyone have a quick rundown on the legal implications of defaulting. I know CA is no-recourse which I assume means the lender can take back the house and nothing more. What about other states?
Can a defaulting borrower be pursued in court and have other assets seized or wages garnished?
by the way, great article, but I admit my brain froze when you got to convexities. Memories of my econ masters.
The fed and IB's have espoused, embraced wide eyed in huge exposure to vast moral hazards.
All I see are more moral hazards.
O Tempores, O Mores"
Interesting post. I saw You Walk Away - Foreclosure Protection Plan and Kit, Mortgage Loan Modification, Foreclosure Assistance, Debt Consolidation, Credit Repair from Foreclosures just yesterday. But it should be noted that you destroyed the entire line of argument in your last paragraph.
"The industry has, in fact, created the conditions in which its rational, and as long as its rational it will go on."
The clear fact is that investors and bankers chose this course of making it rational to default by giving no down loans. With 20%, or even 10%down, there wouldn't by a cost free put. But whose fault is that - the guy who was 'writing "free puts"'.
So in the end, I agree with you completely, except for why you wrote a gigantic post criticizing the guy taking "free puts" when you know full well its the guy writing "free puts" that is to blame.
"Chad Peterson writes: So in the end, I agree with you completely, except for why you wrote a gigantic post criticizing the guy taking "free puts" when you know full well its the guy writing "free puts" that is to blame."
This is exactly right. I tried to make this point, but foolishly left in the word "ruthless." The issue is not the word "ruthless" (hell, call it cucumber), but WHO is being labeled. Here, the lender is, er, cucumber, for having made the loan (and collected the fee).
The lender (mortgagee) is effectively short a call option in terms of interest rate risk.
He is short a put option in terms of credit risk.
The credit risk component also has an impact on interest rate risk.
Credit risk is treated equivalently to prepayment risk in terms of its impact on interest rate risk.
So the lender is additionally short a call option in terms of the interest rate risk that is contingent on credit risk.
Tanta, you get what you give! The bankers and their cohorts were engaged in fraudulent activities that would have been illegal if they had not written the laws. Like my lawyer use to say, you lie with dogs, you get fleas
BIll