Archive for June 24th, 2011

Three Reasons for Strategic Default

I enjoyed this article from today’s Huffington Post, entitled Three Sound Legal and Moral Reasons for Strategic Default.  I particularly like number 2, especially the part that asks:

how do you try the Federal government, mortgage industry, and media going back 100 years?

Here’s the article. …

The standard justification is that “It’s in the contract that the bank gets the house if you default.” Actually, that clause is legally a remedy to a worst-case scenario — not an expected part of the deal. There are three much stronger justifications.

The first is legal and moral: fraud. A huge percentage of the homes sold after 2000 were sold to unsophisticated buyers through a mixture of assurances that their homes would appreciate, could be used as ATMs in the meantime, and that there was no conceivable problem that the mortgage broker could not wiggle around to refinance the home again, usually at even better terms.

Yes, many of the buyers were naive and reckless, and suffering both gullibility and cupidity. But the lenders were dishonest, and preyed on those exact weaknesses. Under these circumstances, the culpability falls on the professional.

No, there is no solid legal case against the mortgage brokers, because there were probably no secret summit meetings planning a conspiracy, and probably not many incriminating emails either. There was simply the word on the grapevine, “Fannie Mae will finance anything! Commission times are here!” Nevertheless, whether or not a winning case can be made in court: lying to customers to make a profit, to the customers’ financial harm, is fraud. And substantial fraud in the course of a sale undercuts the standing of any contract.

(As an added note, every mortgage broker who encouraged a borrower to lie on any loan application involving Federal funding — meaning almost all mortgages — was accessory before the fact to violation of Federal law USC 18, Section 1014. In other words, equally guilty.)

The second is moral and legal: no living American has escaped a continual and confident advertising campaign stating flatly that buying a house is a sound financial investment, and a necessary or even assured part of planning a financially sound retirement.

Pushing home ownership upon Americans as a good investment was not merely real estate agent hype: it was conceived and orchestrated by the Federal government in the early 1900s, pushed by realtors’ organizations, and trumpeted by media for nearly a century until the bubble burst. (Readably described online in Walk Away: The Rise and Fall of the Home-Ownership Myth by Douglas French.)

Americans were assured that a) a home was a winning investment, in fact the winning investment in modern America, and b) that they couldn’t lose. Americans relied on those assurances when they bought the homes. Now that the promise has proved false, they have every moral right to default, because the promised investment didn’t pan out.

Again, no solid legal case, because there is no single defendant to put on trial — how do you try the Federal government, mortgage industry, and media going back 100 years? Nevertheless, in legal terms, equitable remedies come to mind, notably the doctrine of reliance. Reading the history of equitable remedy can give you a headache, but basically it means “fair dealing.” Fair dealing, the buyers did not get.

(Lying to make a profit is not “just show biz,” unless perhaps you are selling tickets to a movie. When I bought my first house in the 1980s, I asked the mortgage broker what he thought of the neighborhood’s chances of appreciation. He answered, “I write mortgages. Ask your real estate agent.” In other words, “I don’t do hype.” Times had changed by 2000, it appears.)

The third is morally repugnant: In 50 years of a more-or-less steadily rising real estate market, banks foreclosed on millions of homes, most of which were worth significantly more than the mortgage. The “defaulters” then were the laid-off, the divorced, and the ill edging towards medical bankruptcy.

Though most states’ laws mandate that when a foreclosed home is auctioned off, the surplus should be paid to the homeowner, there is usually no surplus. This is because there are not many potential buyers with enough cash and nerve to appear at the courthouse steps and smack down a certified check for a house they haven’t even had a chance to inspect.

So the houses usually went back to the bank for the amount of the mortgage, and the banks then flipped them for a profit, quite legally — after the auction was complete and the title had been transferred to them.

This makes contract-thumping moralists more than absurd when they shriek “that the bank didn’t stand to gain on the appreciation, so they shouldn’t bear the burden of risking depreciation.” On the contrary, the banks did gain on the appreciation for 50 years; they lent out money on the assurance of their bean-counters that a certain percentage of tasty homes could be snapped up for nothing, and then perched on their spider webs waiting for the victims of misfortune.

Today the banksters cry in their champagne about the collapse of American morals that they themselves never subscribed to. But the banks have long since gotten their pound of flesh. Now it is time to walk away from false promises, free the money locked up in homes, and let it escape from the mortgage bubble so it can flow back into the Main Street economy.

Mark Stopa

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