A Crisis of Confidence

This article in the Wall Street Journal caught my eye.  Why?  Here's a taste:

Forty-one states and the District of Columbia permit lenders to sue borrowers for mortgage debt still left after a foreclosure sale. The economics of today's battered housing market mean that lenders are doing so more and more.

Foreclosed homes seldom fetch enough to cover the outstanding loan amount, both because buyers financed so much of the purchase price—up to 100% of it during the housing boom—and because today's foreclosures take place following a four-year decline in values.

"Now there are foreclosures that leave banks holding the bag on more than $100,000 in debt," says Michael Cramer, president and chief executive of Dyck O'Neal Inc., an Arlington, Texas, firm that invests in debt. "Before, it didn't make sense [for banks] to expend the resources to go after borrowers; now it doesn't make sense not to." 

Indeed, $100,000 was roughly the average amount by which foreclosure sales fell short of loan balances in hundreds of foreclosures in seven states reviewed by The Wall Street Journal. And 64% of the 4.5 million foreclosures since the start of 2007 have taken place in states that allow deficiency judgments.

Lenders still sue for loan shortfalls in only a small minority of cases where they legally could. Public relations is a limiting factor, some debt-buyers believe. Banks are reluctant to discuss their strategies, but some lenders say they are more likely to seek a deficiency judgment if they perceive the borrower to be a "strategic defaulter" who chose to stop paying because the property lost so much value. 

For years and years and years owning a home has been seen not only as the American dream but also as a potentially lucrative investment.  There were certainly plenty of personal finance experts who warned against viewing your house that way, who pointed out the inherent risk of homeownership, but given the meteoric rise in real estate values from them mid-90s to the mid-00s it's hard to blame people for viewing their homes as investment vehicles.  Now, of course, it's become all too clear that your house can actually become a financial albatross, decreasing in value to the point that you can't afford to move even if it means getting a job in another city after being laid off. Worse, as the article points out, your home can become a debt grenade that blows apart your entire financial existence.

In my opinion there's a kicker here that not a lot of people are talking about.  Many of the people being decimated by the housing crisis have children who are watching this and who are going to come of age believing that homeownership is a risky endeavor.  They'll have experienced the housing crisis viscerally, in much the same way my grandparents experienced the Depression, and I think their behavior will be affected accordingly.  Let's put it this way – my grandparents never gave up their frugal habits.  They reused everything, they saved all leftovers (you learned real fast that my Granny had no expiration dates on the food in her freezer and you ate at your own risk), and pinched every penny within an inch of its life 40+ years after the depression ended and they were living a very comfortable middle class life in Winston-Salem.  You just don't forget those experiences and I think the number of kids who will have seen the flip side of the American Dream will always view homeownership with a great deal more skepticism than those of us who came of age having only seen the positive side of homeownership.

Note: I need to point out that these opinions are mine and don't reflect an official position by my employer or anyone I work with.  

3 thoughts on “A Crisis of Confidence

  1. Bo Houff

    Some good lessons can be learned by all of this as well. Rather than buying the most house one can afford, it may be advisable to buy the house that reasonably satisfies one’s needs and fits comfortably into one’s income level. Making more than the minimum down payment, if possible, is to be encouraged. While the home is most people’s most expensive asset, for most of us it is a mistake to think of it as an investment. We all hope our homes appreciate in value, but unless and until the time comes to sell, it is just that, a home, and just a house. The good news about this is that being “upside down” in one’s mortgage really doesn’t matter, as long as income remains sufficient to make the payments.

  2. Jon Lowder

    That last point is really important Bo. A loss isnt a loss until its realized and people need to remember that. You bring up another aspect of the psychology involved as well. I think much of the spending binge Americans went on was fueled by the feeling of wealth many people had when they saw how much their houses were being assessed for, and much of our current economic environment can be attributed to people feeling poorer because they are in deeper debt than they expected to be. I do think that attitude is going to hang around for a long time and I think thats healthy and actually quite rational.
    I absolutely agree with your point about buying a house thats less than youve qualified for, in large part because I was house poor once and it wasnt fun.

  3. Jim Caserta

    There was a rational reason why people thought their homes were investments (prices were skyrocketing) and why they took actions with that in mind. My wife and I put nearly as much into our 401k’s as we spend on our home payments. If I truly believed that my home was a better investment than stocks (think about the period from mid-2000 to mid-2002) why would I put money into my 401k instead of my home? If I put that 401k money into my home, we would be in a huge home. Have everyone doing that and you’ve got a lot of money flowing into housing.
    The other thing is that when homes are going up in price 25% per year (as they were in FL, CA, AZ, and NV) you never rent. Even if you’re in a home for 6 months, and you know it will only be 6 months, you still buy because the transaction costs are less than the 12% gain in the 6 months. This is totally irrational. My wife and I were recently in that situation and didn’t even think about buying for the intermediate 6 months between homes.
    What will bring younger adults back into housing will be low prices (they’re here to stay) and low interest rates (they’re here to stay too – it will take an economic rebound to get them up). But what people are thinking about now are the advantages of renting. Short-terms, no long-term commitment, no doing the fixing. Really the term is the difference. People will think about how long they will be in a residence. Less than 4-5 years and they will trend towards renting, which is a more rational behavior considering the large transaction costs involved with buying.


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