San Diego Housing Bubble News and Analysis

A lot of verbage,but the main point of most posters is that just because it's legal does not make it right. I can go out and legally cheat on my wife, but that doesn't make it ethical. Another big question for me is who really owns the house?Homebuyer is required to get banks approval to sell,so do you really own the house?If you really owned the house you could sell it at any price and just be held liable for the difference,but I don't think it works that way because the powers that be recognize that the system could then be manipulated to find debtor scapegoats to defraud people,well isn't that what ended up happening anyway.

Great post analyst.

When homebuyers and lenders enter into mortgage contracts, each side takes on risks. Included in the risk that the lender assumes, is that the collateral will maintain value in excess of the loan amount. When that doesn't happen and a homeowner continues to make payments, for whatever reason, they are performing above and beyond the implied expectations of the contract.

I find it no more immoral for borrowers to stop paying in these circumstances than for the lender to foreclose. (Actually, I don't think ethics or morals should even be a consideration. Lender corporations, despite the courts treatment of them as a "person", rarely act out of ethical or moral considerations. They act based of legal considerations.)

Things get a little bit dicier for recourse loans, risks are greater for the borrrower, more options exist for the lender. But morals and ethics still don't come into play in any greater degree. Risks are still taken by the lender. And the legal consequences of failing to pay are spelled out in the contract. Both borrower and lender have to live with those consequences.

walking away from your home when you can afford it is VERY UNETHICAL, but only because the taxpayers are now bailing out the banks because of it.

IF taxpayers were not involved in any way and the system was 100% freemarket, i.e. banks would take losses and shut down then I see absolutely no problem with walking away...it is between the borrower and the bank.

But because of the bailouts this is affecting everyone now so yes it is unethical.

I would argue that to stop paying while continuing to live in the home is unethical. It's trying to play both sides. Breaking the contract but still reaping the benefits (occupation of the house.)

I believe that there is plenty of blame and pain to share among the parties to the contract - borrower loses downpayment and takes credit hit. Lender takes hit to investment and has costs associated with reselling the property. But if the person doesn't vacate and chooses to not pay - in some ways, that's theft. It's kind of like "dining and dashing". They are reaping the benefits without the costs.

This looks like it's related to the "short sale tale" thread.

The guy over there can afford the mortgage but wants out because he's upside down. Even though he may live in the house, that's an investor to me.

We shouldn't be bailing out banks period, and certainly not to reward poor investment choices.

Good point UCGal.

The only caveat I would add is that IF the borrower offers a deed in lieu, and lender rejects it (which almost ALWAYS happens), then the onus is shifted back to the lender. If no deed is offered, and the borrower just stays and waits for a foreclosure sale, I agree entirely.

What your are talking about UCgal, has possible shades of ethical gray. The "diner and dasher" didn't put down a payment for a fine steak and get Hamburger. What if the person feels entitled to use the free rent as repayment of the down payment they were "tricked' into putting into a good sound investment that wasn't. What if they feel entitled to recoup just for the inconvenience of it all?

I think some people figured that if they could borrow money, it meant it was a good idea because the great U.S. doesn't do stupid things.Some people trusted. Stretching things a bit, it was even patriotic to get in game. There must be a reason for it all?

We can't realistically expect that every bubble buyer had an idea of just how foolish the goings on were or how significant the consequences would be(even though piggs did).I don't think most were trying to game anything from the onset.

Many of the subprime people were immigrant ,first generation homeowners.Some were just very unsophisticated. All the people "analyst" mentions in his opening thread were goading them into buying and lying to them when they asked questions about the viability or the investment.

Just trying to put myself in someone elses shoes.Not sure I want to blame them for taking a break if it is legal , even though I take the idea of personal ethics very seriously.

Great post, analyst. One comment, though: everything you're saying holds true only if no fraud or misrepresentation was made in the loan application. I believe, and I strongly believe that, a majority of loans made at the 2005-206 peak involved fraud in one form or another. It could be a vast majority (as in 80% of loans or so). I'm not kidding. A lot of fraud went under the radar.

True story: friend bought house in 2005, he's OK, no problem paying the loan, everything fine, right? Well, he just refinanced to take advantage of lower rates and noticed that the mortgage broker inflated his income by 40% on the original application. Now, he's not about to do anything about it, and I'm sure everything will turn out OK for him (he's got a good job and everything), but think about it for a minute: here is a super-prime guy who's stunned to find a serious misrepresentation on his loan documents. Want to bet how the subprime / option ARM / stated income / no doc applications look like? Please! Fraud was absolutely overwhelming in those years.

And another story, this time about "morality": another friend bought in 2005, sold 2008 due to relocation, lost a lot of money in the process. He didn't short sell, but took out an unsecured loan to pay off his original lender, and he's now paying back that loan. He's got very good income, too, but he could have very well walked away. Whether it was a moral or business decison on his part I don't know (maybe he judged that it's worth paying to avoid damage to his credit). But here you have it: someone who could have easily walked away, but instead decided to bite the bullet.

I think you need to put aside the fact taxpayers' money is involved for a number of reasons. Many of the Piggs do not support the War(s) started by Bush and continued by Obama, yet we pay our taxes. I do not like giving aid to terrorist nations and yet I pay taxes. I agree with the post regarding fraud in the loan application and not having it both ways: not paying, but living there free. It is a complex situation. I am not going to judge anyone for doing what they consider best for their family in any given situation if it is their own home and not one of many investments bought to flip. I have little to no sympathy for people who bought multiple properties with no money down and made liar loans to buy them. They helped create the bubble as did banks and lenders who did not do due diligence when approving their loans.

walking away from your home when you can afford it is VERY UNETHICAL, but only because the taxpayers are now bailing out the banks because of it.

Wrong, we are having to bail out the banks because the banks made the assumption that their side of the risk was covered because RE always goes up. We are having to bail out AIG on credit default swaps because some banks were smart enough to realize that there was a real default risk and that RE does not always go up, while at the same time AIG felt that the credit default swaps were always money-good since RE never goes down.

One of the biggest problems here is that credit default swaps are not regulated as an insurance product while in fact they really are. With a credit default swap, you get paid 'x' per month to cover any eventual loss in principal should the loan default. Looks, walks and talks like an insurance product.

Interesting article.. to read, linky thing here.

Good reminder of the fraud Daniel. However, from a buyers perspective,especially an unsophisticated person's of which there were many, I could see looking at the "fudging" as being desired and encouraged by every single real estate professional they were involved with, all parties up the lending tree and regulators too.

Playing devils advocate,it wasn't lying, it was adjusting for red tape and inefficiency. Almost everyone was in cahoots. With that knowlege and the security gained from the promises that everything was going to be fine, "houses always go up","the thriving economy and inflation is going to drive your earnings through the roof" and the barking about "ownership society", one could easily glance over the fact that they were exaggerating and only hold themselves responsible, when the gig is up, to realities imposed by the deal, self interest intact. In fact it is because everyone was in cahoots that this is what is happening and will happen. I don't see how you hold only the borrower liable for what some people call a top down ponzi scheme.

The only reason that the lender cannot quickly and effectively close out the situation with a foreclosure sale is because that lender had previously participated (along with the real estate sales force) in convincing the owner-occupant-borrower to overpay for the home.

When people receive punitive damages in court cases, it is not because they "deserve" them. And the fact that they accept them does not make them unethical.

The purpose of the punitive damages concept is to exact a substantial penalty from the party allowing harm to occur, so that they will try seriously not to let it happen again. That is also the purpose of "non-recourse" laws.

In the short run, certain parties receive benefits they may not truly deserve. In the long run, other parties are (hopefully) convinced to refrain from inappropriate activities, to the benefit of the larger community.

Totally agree, Russell. Most people didn't realize what they were getting into, and fraud (or "fudging", if you will) was so pervasive that it was more or less considered acceptable practice. "Everybody's doing it", as they say.

But, since analyst's argument is legal and not moral, we can take that line to its logical conclusion. Many mortgage brokers should probably be in jail, if law was to be followed. Some borrowers, too. And a lot of other people up and down the chain. You know, those loan documents have quite a few dotted lines to sign on, for all parties involved. I remember a post by Tanta at CR, long ago, about "representations and warranties". Every party in the chain makes "representations and warranties" to the next party that the loan docs are basically sound. The borower promises the mortgage broker that he didn't lie, the broker promises the mortgage lender, the lender promises the Wall Street bank, and the Wall Street bank promises the final bagholder investor. If fraud is found, each party supposedly is entitled to shove the loan back down the chain or to sue the party preceding it, down to the borrower. But, in the go-go days, nobody really gave this a thought, it was only CYA fine print. As Tanta said, people didn't give any more thought to the possibility of being sued that they did to the possibility of house prices falling.

Again, with or without the bailouts, it is not between the borrower and the lender, because the lawmakers, decades in the past, intentionally enacted a protection for the owner-occupant-borrower. The lawmakers anticipated the real danger of the borrower being convinced to overpay by the concerted action of lenders and the real estate sales force, and pre-specified that the owner-occupant-borrower could obtain relief from the artificially inflated price. Real problem, appropriate relief.

The owner-occupant-borrower is not responsible for the actions of federal officials, which actions are considered to be helpful by some and damaging by others. As a person who pays much more in federal taxes than should be required to fund an appropriately restrained federal government, I am not happy about the risk to taxpayers flowing from current federal government actions.

However, it should be clear to people who spend more than a few minutes studying the current challenges that federal funds flowing to financial companies is more for the rescue of the ultimate investors on the other side of those financial companies than it is for the rescue of the financial companies themselves. These ultimate investors include:
individuals directly
individual retirement accounts
union retirement funds
corporate retirement funds
insurance companies (investing premium revenue)
state governments
county governments
city governments
school districts
foreign governments

This is not to say that the financial companies do not receive some undeserved benefit. They do. It is unfortunately unavoidable that they receive such undeserved benefit from the act of rescuing the intended beneficiaries.

Some will ask why the federal funds do not flow directly to the ultimate intended beneficiaries, bypassing the intermediary financial companies. It is because the records, resources, and human knowledge necessary to enable the flow of funds to the ultimate intended beneficiaries will not remain in place if the intermediary financial companies are designated for liquidation.

A lender has two tasks:
1. Evaluate the property.
2. Evaluate the borrower.
Both are easily accomplished by a serious lender living up to lender responsibilities. Even for people with complex income situations, there are procedures for the borrower to have tax records released to the lender directly by the taxing authorities.

If a lender does not detect borrower fraud, it is because the lender is not trying, perhaps because the lender is itself engaging in fraudulent activities.

Absolutely so, analyst. But here comes the legal question: if borrowers signed fraudulent documents (with the full or partial complicity of other parties, like mortgage brokers, etc), are they liable? I'd say they are. I'm not an attorney, but I think fine print is there for a reason. They could claim that they were encouraged to file a false application (I'm sure it happened a lot). But I don't think that claim would stand up in court. The "rep and warranty" business is a very serious legal business, the whole secondary market depends on it. No bank would buy a loan without a "rep and warranty". They need to have someone to sue if fraud turns up. And the lawsuits could come down the chain all the way to the person who signed on the application (the borrower).

I perfectly understand and agree with your point about the non-recourse provisions of the law, but I really think it doesn't cover fraud. If I go to H&R Block and collude with my preparer to file a fraudulent tax return, I don't get a free pass just because the preparer cajoled me into it.

You are right, Daniel. I think most people know you are. Without knowing all the specifics, economic and legal liabilities could be brought to the borrower, mortgage brokers ect.

I'd add to this and say that if the contract doesn't specifically say that not paying the loan is breach of contract, then what is the problem ?

I mean if it says something to the effect of "if the borrower cannot pay the loan, then x, y, and z happens" then there are no ethical issues at all because not paying the loan is covered in the contract. If it says the borrower will make good faith efforts to pay, regarless of circumstances, then there may be some ethical issues. That is - the ethics involved vary directly with the contract signed.

Also, keep in mind that, because the bank knows it is a non-recourse loan, the interest rate is likely higher than if it were a recourse loan, so the borrower is really paying for the right to walk away without recourse and should have the right to do so without any ethical encumberances.

Being a fan of choice, I'd like to see buyers have their choice of recourse or non-recourse loans, where the interest rate spread between a recourse and non-recourse loan changes based on the market's perception of the risks involved.

Isn't the unethical part of the fraudulent transacion the up-front committing of the fraud itself and not the walking away ?

My original post did not speak to the question of intentional misstatements. Absent intentional misstatements, everything stands as written.

Now let's examine the case of intentional misstatements. It is not plausible to me that borrowers in any significant numbers can successfully misrepresent their financial capabilities if the lender seriously attempts to verify them. So I do not accept the concept of one-sided misrepresentation by the borrower. For all lenders where misrepresentation is a recurring theme, I believe there was material participation by the lender.

I would further predict that, since borrowers know that any misrepresentations can be easily discovered by the lender, joint (lender and borrower) misrepresentation was instigated by the lender, not the borrower, in the vast majority of cases.

If there is joint misrepresentation, I would expect that the lender (co-conspirator) has no case against the borrower. So as between lender and borrower, the effect of the non-recourse laws would not be altered, and decisions about the progression of events leading to a foreclosure sale by auction would be unaffected.

The difficulty of ultimately determining who misrepresented what to whom is the reason, I believe, why the non-recourse laws were written, to avoid the need to ever debate the matter with respect to owner-occupants. Just do a proper appraisal and maintain a proper loan-to-value ratio, and there will never be a problem.

The failure of the "professionals" to do their jobs, and the lax regulation environment which allowed them to operate in that manner, are the causes of the problem that people should be focused on. Focusing on the greedy owner-occupant-borrowers detracts from the time spent discussing the regulatory rules which need to be imposed on the people who work every day in businesses related to owner-occupied real estate.

Russell, I completely concur. I know several people underwater and they are ALL paying their mortgages. Some friends sold a condo and bought a house in 2006, and while in escrow, the lender kept attempting to get them to get a subprime loan, when in fact, they were fully qualified for a 30 year fixed. They were fighting with this lender to stay with the 30 year, and the lender continued to badger them about getting the subprime loan. They switched lenders, got the 30 year fixed, and that was that. Now, how many people could have been snowed with lender's salespitch to get the subprime loan? This couple happenned to be more knowledgeable and experienced.

I acknowledge that there are valid points to be made on both sides of this argument.

But I am ticked off by people pretending that there isn't often a selfish motive when arguments are made that it's OK to walk away from repaying your debts. Let's face it, not many of us think of ourselves as investors who loaned large amounts of our own personal money to people overpaying for homes, and might lose a $1 of our own money for each $1 that's not repaid. But lots of us are, or plan to be, homeowners. As homeowners, it would be nice if we could avoid repaying our mortgage, and feel no pangs of conscience or the pain of social opprobrium. We may never have done it, and we may not have an opportunity to do it now, but we wouldn't mind having the option to do it in the future. "It's OK if I steal a little, isn't it". My answer is No.

Excellent posts, analyst!

You are absolutely correct -- the lenders are most to blame for this mess, along with the regulators who knew what was happening and refused to fix the problems (even blocked attempts by others to fix the problems).

While many borrowers were indeed guilty of fraud, for the most part, they couldn't have done it without the complicity of the lending establishment.

That's the crux of the issue, you only have to be accountable to you, don't worry about everyone else. We will get through this and we will get through the next thing, but in the end, you only need to worry about how you feel about you.

Not paying your debts, breaking your promises, cheating on your taxes, having an abortion, cheating on your spouse, lying to your kids, faking erectile dysfuntion just to get a viagra prescription for sport, leaving the toilet seat up, whatever it is that you feel is ethical or unethical yet isn't illegal, let it go, free yourself of the hall monitor duties and just worry about impressing yourself.

I'm more than halfway though my time on the planet and i'll be damned if I am going to turn back now on the undefeated record for at least five of the eight aforementioned examples, some things define you and even if they cost you a little in getting ahead as far as money goes, once lost, principles cannot be reaquired.

This has been a viral e-mail, i'm sure you've all gotten it before but as a reminder

http://acct.tamu.edu/smith/success.htm

"Honor is better than honors" -Abe Lincoln

Being selfish, by itself, is neither illegal nor unethical.

Recall that this discussion is about non-recourse loans, whose entire proceeds went to the purchase of the homes. No part of the money went to the borrowers.

What is it that is being stolen?

The borrowers are not holding any of the lender-provided money.

The lenders, who were given clear notice not to lend more than the house is actually worth, can take back the house at any time. The fact that the lenders have agreed to a deal that precludes them from doing so is nobody's fault but their own.

The borrowers will ultimately be returned to their beginning positions, without homes and without loan proceeds, and will have lost any money that they put in along the way.

Any free rent benefit that the borrowers receive should be viewed in the same way as punitive damage awards - money that the law awards to parties who don't "deserve" it, in order to penalize other parties who are responsible for harm caused by their intentional acts or negligence.

This is why people hate lawyers. Illegal? no. Unethical? debatable. Something to be ashamed of?
Yes.

I guess it all depends on what your definition of "is" is. Sorry, didn't mean to pull a lewinski, but where is the mention of right and wrong, business ethics and illegality aside, many of us still believe in that right and wrong crap, some of us choose to live by it, perhaps to our detriment, but it keeps us warm on cold nights.

It all boils down to people you want to drink with and people you dont want to drink with. People who's funeral you will miss a playoff game to attend and people you wouldn't miss a midseason clippers game to send off. The choice is yours, pick who you want to be, the law and your ethics class may give you a pass but i wont save you a seat at the bar. I'll give you a pass if you cant uphold your obligation, but if you choose not to because it will benefit you, then you aren't worth my time. Who doesn't know a guy who pays his child support to be in compliance with the law but fails to parent his child.

Illegal? no. Unethical? debatable. Something to be ashamed of? Yes.

be a big boy and make your momma proud.

It appears that the most important thought is not getting through to some.

When you look at a situation and observe ten categories of participants, who have all done wrong, you should not spend your time and mental energy addressing the actions of the minor players. Without the wrong-doing of the financial institutions and the inaction (some would say collusion) of the government and appointed regulators, dishonest borrowers would have zero impact on your life and finances.

The time and mental energy spent addressing the sins of the little players would be better spent addressing the sins of the big players, who were and are taking every opportunity to defraud investors and/or loot the U. S. Treasury, effectively stealing from you and I, the taxpayers. That is the undeserved gain to focus on, not the fact that some upside-down borrowers are failing to repay their loans, or benefitting from a free-rent situation.

Worry less about the borrowers, and more about the big picture. If the primary perpetrators are not reined in, they will continue causing further great harm.

Absolutely true, analyst.

Again, good posts.

analyst, when I read your argument, what I see is, to paraphrase: "Those people over there guarding the gold at Fort Leavenworth left the door open. Other people are stealing the gold. Let's blame the people who left the door open, and not assign any blame or responsibility on the people who stole the gold. Hell, they hardly even stole it, because whenever you see a door open, everything inside is yours for the taking."

I'm sure it's not how you see it. But it sure is very convenient to pretend that only the guardians of the gate are responsible, and those who take advantage of the unguarded gate are blameless.

By the way, TG, I think your writing style, and even just your style of arguing and dealing with others, is remarkable. I hope you're being paid a lot for what you do at work. I know a lot of people in the industry I work in who appear less capable, and who are making over $500K/yr, or even over $1 mill/yr.

Kev374 wrote:

IF taxpayers were not involved in any way and the system was 100% freemarket, i.e. banks would take losses and shut down then I see absolutely no problem with walking away...it is between the borrower and the bank.

But because of the bailouts this is affecting everyone now so yes it is unethical.

So what you are saying is that the government is spending your money unethically? Thats an argument I can understand - even though the Govt, misguided as it may be, is just clumsily trying to choose the lesser of two evils.