Strategic Defaults May Force Lenders and Servicers To Modify Loans, Including Principle Reductions

The writing is on the wall. Many people across the United States have decided that it just doesn’t make an ounce of economic sense to continue paying on a mortgage when the underlying asset isn’t worth half of what they owe on paper. A lot of these folks could afford to continue to make payments, but they’re deciding its just not worth it. 

In a May 3rd article on the Freddie Mac site,  Executive Vice President Don Bisenius implores people to continue paying on their mortgage if they can afford to do so. He claims that people walking away from their homes harms communities and further brings down property values.  Mandelman Matters already tears this guy a new one, so I won’t go that route, but I do believe that the banksters might be running a little scared these days.


Bisenius  says this:

While I understand how that might well be a good decision for certain borrowers, that doesn’t make it good social policy

and this:

For those who have not suffered any disruption in income and have a longer time horizon, simply continuing to pay the bills might be best.

Where were he and all his banker brethren when they were making loans they KNEW would fail? Did that make “good social policy?”  I wrote about how subprime loans were a recipe for disaster here.

Where are they now when millions of families are facing foreclosure due to these unsustainable loans and due to the economic downturn they caused? Have they been scrambling to help homeowners by modifying mortgages and even *gasp* writing down principle so that the security of the mortgage reflects the true value of the home rather than a set of meaningless numbers on a balance sheet?

The answer is, no they haven’t. So some homeowners have decided they’ve had enough. Some could afford to make the payments but have decided that it makes no economic sense for them to continue to do so, and some who cannot afford the payments anymore are deciding that the hassles entailed in getting a loan modification are not worth the little help it would give them.

The numbers of homeowners willing to risk their credit and walk away from their homes are rising, and soon, the banks who haven’t wanted to take the write down in value and therefore haven’t exactly gone out of their way to modify homeowners’ mortgages, will have to face the music.  Either they will lump it and start really modifying loans including drastic cuts in principle, or they will be faced with an inventory of homes not worth the paper they’re holding with no way to unload them fast enough. In either case the result will be the same: a true reconciliation of the banks’ balance sheets, but in the former case, that loss will be blunted by performing and sustainable mortgages.

I’ll close this with another quote from the estimable Don Bisenius where he trots out the mortgage industry’s reasoning for opposing pretty much everything that could actually help homeowners, and in turn right the sinking ship that is our economy:

Should strategic defaults become more common, mortgage guarantors and investors, including Freddie Mac, would need to factor this risk more prominently into their credit policies and prices. The likely impact on future homebuyers: the cost of a mortgage will go up and credit terms will be less flexible. Thus, the impact of strategic defaulters on still more families might be more expensive mortgages and loans that are more difficult to obtain.

Yes, that’s right. It will cost more to get a mortgage if …fill in the blank here…: lenders are forced to modify loans,  if borrowers can get their loan terms modified and principle balance reduced in bankruptcy court, if you force us to do write-downs, and now, yes, if people act in their own self interest and walk away from homes so underwater it simply makes zero financial sense to stay.

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