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Old 12-11-2009, 09:48 AM   #41
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Not sure if the rates are different from the states that allow banks to go after lender and those that do not.... probably not since FNMA etc. were the big dogs in lending...

BUT, there is a difference in costs to someone who puts zero down and someone who puts 20%... I put 20% down to save on PMI... I think it was a few hundred a month... not sure since I told them up front that I was not going to need it....

So the cost to the borrower is real if you don't have much skin in the game...
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Old 12-11-2009, 06:56 PM   #42
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If you were running a business and you had an asset that was not 'productive' for the costs.... and you could get a similar asset for a lot less... and your debt was non-recourse.... you would be a fool not to get the cheaper asset...
I'm not a lawyer but I seem to remember hearing, somewhere, somehow, that if you're a public company in the above situation you have a DUTY to your shareholders to get the cheaper asset. If a company you're contracting with doesn't write enough of a penalty into the contract to keep you from defaulting, it's their fault, not yours.

Again, no law degree here. But if this is true it causes one to think.

Interestingly (to me, anyway), the question of defaulting on a mortgage was asked a few years back and I responded that I wouldn't walk away if I were under water. That was before the housing crisis, and before the house I sold for $405 three years ago came back on the market at $167K.

Ethics are getting costlier by the minute.
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Old 12-11-2009, 08:35 PM   #43
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I'm not a lawyer but I seem to remember hearing, somewhere, somehow, that if you're a public company in the above situation you have a DUTY to your shareholders to get the cheaper asset. If a company you're contracting with doesn't write enough of a penalty into the contract to keep you from defaulting, it's their fault, not yours.

Again, no law degree here. But if this is true it causes one to think.

Interestingly (to me, anyway), the question of defaulting on a mortgage was asked a few years back and I responded that I wouldn't walk away if I were under water. That was before the housing crisis, and before the house I sold for $405 three years ago came back on the market at $167K.

Ethics are getting costlier by the minute.
Caroline:

You are describing the efficient default theory. It may be envisioned as follows: Suppose you are a manufacturer and have a contract to buy from one company all your requirements for an important widget that is a component of your product. Further suppose that the market price of such widgets has now dropped far below the price you are paying under your contract. Under the efficient default theory, you should default under your contract and buy the widgets on the open market if the savings from doing so exceeds the damages you will be required to pay to the other contracting party.

Under modern corporation law, the board of directors has a duty to shareholders to default on contracts that are not cost efficient for the company. I see no reason why this should not also hold true for individuals.
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Old 12-11-2009, 08:59 PM   #44
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I would hope the "efficient default" theory leaves a lot of room for discretion on the part of decisionmakers.

In 1973 there was a shortage of tomatoes which led to a shortage of ketchup. Prices went way up. Heinz had a decades-long relationship with McDonalds, but elected not to fill the normal orders from McDonalds during the shortage, as a lot more money could be made selling the scarce ketchup in supermarkets. I don't even know if they had a contract, but McDonalds certainly had an expectation that their relationship would mean something.

McDonalds has never forgotten the snub. To this day, over 35 years later, McDonalds will buy almost no ketchup from Heinz for their US restaurants (exception--you can get it in Pittsburgh and in one pocket in MN or WI where the Krok family insisted on Heinz.). McDonalds formulated their own ketchup and started having it made by regional sources. Good and cheap.

Now, if they had a contract in 1973, Heinz probably made a good short-term financial decision to default and pay any damages to MickeyDees and sell ketchup at retail. But that penny-wise, pound foolish choice cost them the biggest ketchup contract in the world for three and a half decades.

Smart managers will certainly look well beyond the simple contract to determine the true costs of their decisions.

McDonalds is just now starting to buy Heinz for some of their foreign stores.
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Old 12-11-2009, 09:20 PM   #45
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I should have used the qualifier "all other things being equal". Boards are generally protected by the business judgment rule. If, in their best exercise of business judgment, it would have been prudent to stick with a money-losing contract for the sake of the longer term relationship, then it is unlikely a court would second guess that decision. But that's the chances you take being a director.
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Old 12-11-2009, 10:37 PM   #46
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Don't forget that it is the newspaper's job (new media as well) to provoke reactions just like this. It's like poking the beehive with a stick - the bees swarm out on cue and buzz around every time. The WSJ editors would be thrilled to see all of us riled up like this. Next week, they'll write one on welfare mothers or illegal aliens and we'll buzz again.
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Old 12-12-2009, 09:55 AM   #47
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I should have used the qualifier "all other things being equal". Boards are generally protected by the business judgment rule. If, in their best exercise of business judgment, it would have been prudent to stick with a money-losing contract for the sake of the longer term relationship, then it is unlikely a court would second guess that decision. But that's the chances you take being a director.

Samclean..... Your point is well taken... supplying a product for your customers to keep your customers is very important... the cost of getting a new customer is huge... so losing some money short term is not a big deal...

My boss has said that after this crisis, the people we deal with will remember who helped them out when they were down... it is relationship building...


What may original post was dealing more with the real estate (or other production asset)...


As an example... I remember a LONG time ago some company was leasing computers... and the people who leased had an option to put the computer back for a newer one... surprise, surprise, they had a LOT of return for newer and better computers... because there was no penalty... but even if the penalty was there, it still might be better to pay the penalty and get a new one...

So to me, an individual doing it is the same... I can tell you that IF I had bought a house for $400K and it was now worth $175ish.... and there was no way they could get the difference since it was non-recourse... I would probably return the keys.... now, this is an extreme case... since the cost to me is real... a lower credit rating... a 1099 for $225K (you still have to pay the tax on that don't you)...

But, if the loan was $150K and the house was $120K... then the 'savings' does not justify the costs....

BTW, it does matter if you have a high interest rate or not.... I saw something on nightline where the rate for someone in Phily was 9% and going up to 15%!!! Someone ripping off customers like that deserves to get screwed back.....
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Old 12-12-2009, 10:12 AM   #48
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Don't forget that it is the newspaper's job (new media as well) to provoke reactions just like this. It's like poking the beehive with a stick - the bees swarm out on cue and buzz around every time. The WSJ editors would be thrilled to see all of us riled up like this. Next week, they'll write one on welfare mothers or illegal aliens and we'll buzz again.
I'm not "riled up", and I think this discussion resulting from the news article has been very enlightening. I've changed my mind on the issue as a result. To those who say "no one ever changes their positions as a result of these posts," I can now point them toward this thread.

Former view: Defaulting on a home mortgage when you have the means to pay is cheating. You had a contract with the lender and you deliberately broke your promise to pay.

New view: This is a business deal, a contract. The obligations of both parties need to be fully spelled out in the contract, and no one owes anything that's not in the contract. Lenders need to assure the contract provides them sufficient protection from default (whatever causes it) and if the law requires them to take higher levels of risk (e.g. no recourse) then they should price the product accordingly or take other steps (less loan-to-value, etc). This is not a loan from your brother-in-law.
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Old 12-12-2009, 10:20 AM   #49
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If that's as far as it went, then perhaps I can see your "its just a contract position" but in this case, I was never consulted or a party to the contract, but I will still have to pay for these defaults with bank bailouts, toxic asset programs and higher taxes. It's not as simple as just get away with whatever isn't explicitly illegal.

In the article, the people walking away deliberately stop payments to pile up money until the bank takes action. Meanwhile they have plenty of income and assets, including they own multiple rental properties themselves. They are just more aggressive about taking advantage where they don't think the counter party can enforce the agreement.
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Old 12-12-2009, 10:35 AM   #50
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If that's as far as it went, then perhaps I can see your "its just a contract position" but in this case, I was never consulted or a party to the contract, but I will still have to pay for these defaults with bank bailouts, toxic asset programs and higher taxes.
It seems to me that your gripe is properly with the government that put you on the hook to bail out these lenders. Did you sign up for that? I know I didn't.

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In the article, the people walking away deliberately stop payments to pile up money until the bank takes action. Meanwhile they have plenty of income and assets, including they own multiple rental properties themselves. They are just more aggressive about taking advantage where they don't think the counter party can enforce the agreement.
They are doing exactly what is allowed by the contract. The bank should have written a better contract--more money down, etc. The bank was greedy aggressive and wanted to write a bunch of loans, and apparently believed house prices would never come down. Now they are reaping what they sowed. The borrower was never obligated to sell other properties to pay the loan, sell their cars, eat beans every night, or anything else.
The borrowers will take a credit rating hit which will put other potential lenders on notice that these folks defaulted on a debt. That will let others price their products to these people appropriately.
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Old 12-12-2009, 10:54 AM   #51
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Interesting discussion. It's not often that it's the banks who fail to read the small print and end up getting scr*wed. The fact that lenders have realized that they can walk away from the debt with no re-course, and many are choosing to do so, is a risk the banks took when they initially made the loans. They should have been more diligent at the outset.
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Old 12-12-2009, 11:04 AM   #52
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When we lived in Houston years ago, people were walking away from their houses.

If the bank repossesses and sells at a loss to them, they could go after the previous owners for the balance or forget about it and the debt is effectively forgiven.

A debt forgiven is income, according to the IRS. You must pay taxes on it in the year it is forgiven.

Now, the creditor does not have the option of paying off, say, a $200,000 shortfall a month at a time. He must pay the IRS maybe $70,000 all at once ($200k at 35%).

I gather this is not often done, but it is there.
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Old 12-13-2009, 05:31 PM   #53
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You guys are right regarding the forgiveness of debt in general. However our glorious leaders have decided that up to $2 million of forgiven home-related debt should not be treated as income. The Mortgage Forgiveness Debt Relief Act and Debt Cancellation

So I'm sure this just serves to amplify the strategic defaulting. Many would think twice about defaulting on a loan with a $2 million deficiency if they were going to face a $700,000+ tax bill. That was actually one of the big sticks in the lender's tool box to force deadbeats into paying. Ie pay your debt or we are going to write it off and let Big Mean Uncle Sam come knockin on your door to break your knee-caps collect their tax.

The housing racket is a pretty good casino. You make a ton of money on a house, the income is tax free. You lose a lot of money on the house and have millions in debt forgiven, you owe no tax on the forgiveness. Plus interest on the house is deductible. Anyone else wondering why we love houses so much?
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Old 12-13-2009, 06:00 PM   #54
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I would look at defaulting borrowers and say they are not creditworthy (in hindsight of course). Whatever reason for the default, it is a default. But yes, I understand the distinction you are making between those who simply don't have the cash flow available to service the mortgage versus these "strategic defaulters" that are making a financial decision to not pay the mortgage in spite of their ability to pay it.
What is rarely mentioned is that so many of the deadbeats with an income took the adjustable rate for several years to enhance their standard of living with way below market rates. Those folks should be considered as opportunistic scammers for their gambling at our expense. I know of more than 1 person who enjoyed 2.5 to 3.5 loans on a 3 to 5 year step up. Shame on the banks for offering those terms at all ever!
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Old 12-13-2009, 06:26 PM   #55
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FYI, The Mortgage Forgiveness Debt Relief Act of 2007 eliminate the Federal income tax on forgiven mortgage debt. As long the amount forgiven is under $2 million. So don't try this with your (formerly) $10 million house with $9 million mortgage. Interestingly enough even under the old rules if you declared bankruptcy at the same time, they IRS didn't treated the debt as being income.

The forgiveness law is suppose to expire on Dec 31, 2009, but I would be shocked if it doesn't get extended by Congress. Note you still may owe state income taxes, since many states didn't go along with the change.
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Old 12-13-2009, 07:25 PM   #56
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What is rarely mentioned is that so many of the deadbeats with an income took the adjustable rate for several years to enhance their standard of living with way below market rates. Those folks should be considered as opportunistic scammers for their gambling at our expense. I know of more than 1 person who enjoyed 2.5 to 3.5 loans on a 3 to 5 year step up. Shame on the banks for offering those terms at all ever!
I described my Niece house purchase a couple of years ago. He is a minister, and she does tutoring, teachers aide,some tax stuff, and home schools her 3 kids. A terrific hardworking couple in their late 20s that give very religious Christians a good name.

They sold a house in Arrowhead (ski resort area near LA) about 4 years ago near the top of the market. He went back to school to get his masters. A couple of years ago they bought a house in Riverside, CA ground zero for foreclosure. A very nice place 10 years old, across from a park, nice neighborhood 2,000' sq, pool. Formerly it sold for 620K, they bought it for 300K. He lost his job this past Sept, and they discovered that house had dropped from 300K to 240-250. Actually the Realtor said they could probably get offers in about 20-30K higher than that but it wouldn't appraise above 250K. Fortunately, they found a buyer, but I suspect they will owe a bit a closing. Which they will pay.

Even more fortunately he found a better minister job at higher pay in Chico, Ca (Northern California). So once again they are going be buying a house, (even after losing 60K...). I doubt that there credit score is going to be positively impacted by paying the mortgage which legally didn't have to do.

I going to urge them to consider a ARM (despite the low interest rates) with as low a down as possible, to give them the option of a strategic default, if CA Real Estate continues to fall. I believe as long as Banks allow folks to continue to borrow money at really low rates with relatively modest penalties for default, we are foolish to not take advantage of it.

My position and evolution is the same as Sam (I just got there a few month earlier). As bank owner, I want banks to maximize their profits within the limits of the law. I expect individuals to minimize their costs and losses as long as they do so legally.

Both side need to take into account the long-term consequences of short-term actions. So for banks, foreclosing on Xmas day is really stupid, as is refusing to negotiate with folks trying to make a mortgage work. For individuals walking out of mortgage for less the $10,000 is stupid because of the credit score impact.


As a society, the housing market is filled with perverse incentives which makes it very expensive for lenders and borrowers to do the morally correct thing. We need to very quickly either fix these incentives, (my first choice) or accept that people are going to act their own financial best interests.

Which means we need to stop casting moral judgments on both borrowers and lenders when the do so. So no more getting angry at banks foreclosing, jacking up interest rates and fees, buyer getting a new mortgage and than strategically defaulting on there old one, or living in the house rent free tell they are evicted.
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Old 12-13-2009, 07:45 PM   #57
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I have a very close friend of mine who is 61. He worked all his life and spent more than he should have. Now he tells me that he's working off the books and stopped paying his mortgage and is trying to do a loan modification via his bank.

He also put a phony claim into SS for a bad back saying he can't work any longer. He even had a buddy of his whose an orthopedic surgeon fill out papers saying he's completely disabled.

I tried to talk to him about this but his answer to me was the following. He said he was sick and tired of everyone else getting a free ride and now it's his turn. He brought up a few other guys we know that are out on phony injuries from the Police and Fire Depts. These guys are getting over 100K a year and there isn't a thing wrong with them.

So I can see his point but ya gotta put your head down on the pillow at night, no?

Seems a lot of folks are trying to get a piece of the Obama pie.
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Old 12-13-2009, 08:02 PM   #58
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Seems a lot of folks are trying to get a piece of the Obama pie.
Well, I wouldn't lay this situation at the feet of President Obama. But, I do think it's fair to say that the more we encourage people to be dependent on the government, the more people will see that others are getting a bigger slice and see no reason not to do the same.
It's interesting to see the situation in the small, poor countries when the government artificially limits the price or provides subsidies for the price of a few things (usually it is bread, tortillas, gasoline, etc). Sooner or later, without fail, there will be riots in that country when there is a shortage of the artificially "cheap" commodity, or when the government allows the prices to go up slightly. People take to the streets with bricks and torches, mad at the government. But, in places where prices are at the market level, riots are a lot less frequent. When everyone understands that the prices (or whatever) are responding to market forces, then there's much less of a political element to things. On the other hand, when the game is changed and prices are seen as evidence of a political decision by the government, then it is logical and right to take to the streets to have the decision changed. The more government is involved with setting prices, handing out goodies, picking favored businesses, etc, the more people will see the government as the crux of their problems.
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Old 12-13-2009, 08:12 PM   #59
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It's one thing to want a piece of the Obama pie and quite another for those who will not get any that I pity. If this "what can I get philosophy of greed and screw your neighbor" continues, we may become a nation of oldsters very quickly as our youth immigrate away from a debt load that is unsustainable. Australia, Canada and New Zealand all have openings for our educated youth and they welcome talent and have much more conservative spending and debt policies. Just one more thing to contemplate.
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Old 12-13-2009, 08:31 PM   #60
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Well then Connie, you can pity me as I'm not getting any of it. I went back to work PT because of the losses I had in the market in the last year. I didn't fall down at work, take out a mortgage and say I can't pay it or tell SS to send me money for no reason. I'm just plugging away like most honest folks.
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