Last month the Wall Street Journal published a front-page story entitled, “American Dream 2: Default, Then Rent”. Written by Mark Whitehouse, the story focused on two people who decided to walk away from their home mortgages and now rent luxury homes in Palmdale, California for considerably less money than they were previously paying to own their homes.
Nobody likes to hear about another American losing his or her home. Homeownership has always been a central theme in what is considered the “American dream”. But according to this story, the whole idea of homeownership may be radically changing as a result of the current economic downturn. Along with that change, the way Americans look at debt and indebtedness may also undergo a striking transformation that could reshape everything we ever knew about living in America.
The two featured in the WSJ article were Ms. Shana Richey, a schoolteacher and Jay Fernandez, a Firefighter. What they did that made them worthy of mention on the front page of the Journal was not “losing” their homes but rather choosing to walk away from their homes and mortgages because they no longer wanted to pay on a mortgage that was considerably more than the currently appraised value of their property.
In the case of Ms. Richey, the Journal reported that she had a $430,000 mortgage on a home that was now valued at about $230,000. Richey could have continued to make her $3,700 per month mortgage payment, but she and her husband decided to simply stop paying their mortgage and moved to a luxury home in Palmdale, complete with swimming pool, that they rent for just $2,195.00 a month.
The story went on to report that the Richey’s are using part of the $1,500 a month they are no longer paying toward their mortgage to buy season tickets to Disneyland and take their family of five on a cruise to Mexico this coming March.
The case of Fernandez was similar. He walked away from the two mortgages he had on his home and now rents a luxury home in Palmdale. The money he saved he has thus far used for concert tickets and to maintain his BMW 6 Series coupe.
Ultimately, taxpayers will pick up the tab for Richey, Fernandez and everyone else who decides to walk away from their homes. The banks initially take the loss and then taxpayers pony up to cover the bank’s losses.
Now I know that the majority of you reading this feel at least a slight sense of outrage in learning that people who can well afford to make their mortgage payments are simply walking away and leaving you and every other taxpayer to pay for their mistake. But before you get too worked up, you should understand a couple of things.
First, California is one of only ten states that prohibit lenders from going after the other assets of people whose homes are foreclosed upon. The forty remaining states are ostensibly owned by the banks, who long ago bought legislation insuring that they can take the bread from your baby’s mouth if you miss so much as a single payment on your mortgage.
Secondly, while electing to simply walk away from a mortgage may seem morally objectionable to many Americans,
some economists insist
that it is actually good
for the economy and
will speed up the process of ending the
argue that money being
used to pay for non-existent equity does nothing to stimulate the national economy. So in fact, Ms. Richy’s decision to use that money to buy tickets to Disneyland and take her family on a cruise and Mr. Fernandez’s decision to buy concert tickets and tool around in his Beamer will help stimulate the economy and create jobs, thus helping to end the current recession.
I thought about this article for a long time after I had finished reading it. And to be honest about it, I’m still not quite sure what to think. On the one hand, I was taught from birth that a man’s word is his bond and when you agree to something, you damn well live up to your side of the bargain. But another part of me reasons that it’s just plain stupid to throw good money after bad. And I have to ask if all those bankers and captains of industry that charted our economy onto rocks can stand there straight faced and take billions in taxpayer money to pay for their mistakes, then what’s so wrong about the little guy doing the same thing on a much smaller scale?
What really puzzled me about this story is just why the Wall Street Journal would even publish a story like this in the first place? Why would America’s number one business publication put a feature on their front page that basically talks about how it’s good and smart and even patriotic in a surreal sort of way, to walk away from a personal debtowed to a mortgage lender?
The WSJ article cited credit firm Experian and consulting firm Oliver Wyman who forecasted that more than one million homeowners would opt for “strategic defaults” on their mortgages during 2009. They stated that this would be a 400 percent increase in such defaults from those occurring during 2007. But I had to wonder if that number would increase after more and more people read what I was reading?
According to some analysts, as many as 43 percent of all homeowners may be underwater on their mortgages by the end of 2010. That means they will owe more money on their various mortgages than their home is worth. Naturally, some homeowners will remain in their homes long enough to regain lost equity, but even banks don’t necessarily want those numbers to rise.
Even though the terms of most mortgages in the U.S. are twenty to thirty years, bankers actually assume a loan lifespan of around seven years. This is because the average American changes their home about every 3.5 years and most mortgages are closed and paid off long before their twenty or thirty year term. Bankers not only like that mortgages close early, they actually count on it.
All the money the U.S. has borrowed and presently is borrowing in an effort to spend the economy
out of recession is going to have to be repaid to the foreign banks that have extended us those loans. But because the U.S. undertook this
debt, the value of the U.S. dollar is decreasing. This means that current homeowners with twenty or thirty year mortgages are paying back that money in dollars of less and less value each and every month. It also means that homeowners, if they maintain current low interest mortgages, will realize far more value in their homes as time passes.
Assume that you paid $500,000 for your home and carry a $400,000 mortgage on the property. When inflation sets in – as it must because of our trillions of national debt – you will be returning money of lesser value than you initially borrowed from the bank. If the rate of inflation is 10 percent per year, then the value of the money you return to the bank in the form of mortgage payments decreases ten percent every year – compounded annually! Naturally, bankers increase interest rates on mortgages during inflationary times as we witnessed in 1980 when mortgage rates rose to over 21 percent.
Make no mistake about it; inflation and higher interest rates are on the horizon. When these rates start to rise, bankers don’t want to see a lot of Americans sitting on 4 and 5 percent mortgages when inflation is running at ten percent or more and interest rates are rising to keep pace. Normally, bankers wouldn’t worry too much because the average American moves so often. But if too many Americans are underwater in their mortgages, they may not be able to move and may opt
to stay put, paying on that
4 or 5 percent mortgage
that could end up
costing banks billions
in additional losses!
And so this story
appeared on the front
page of the Wall Street
Journal suggesting that
it may be a good idea for some people to walk away from their mortgages. And having lived long enough to know that nothing gets published in that paper that isn’t good for business and bankers, I just had to try and figure out what the real angle of this story was all about.
I don’t know if I did figure it out. All I really know for certain is that in my relatively short time on this planet, I have witnessed the American economy alternate between stagnation and prosperity a half dozen times. And I know that all the people who today may complain about their high mortgage payments, may well come to regret giving them up in the relatively near future. If you are sitting on a four or five percent thirty year mortgage – regardless of how high your payment may seem right now – you are, as they used to say during the Great Depression era, sitting pretty.