Zach Fox keeps stirring the pot – where did he learn that?
From his SNL blog:
On the crucial question of whether underwater borrowers will continue to pay their mortgages or walk away, Luigi Zingales, a professor of finance at the University of Chicago Booth School of Business, told SNL that much could depend on whether a new business idea gets off the ground.
Zingales’ comments, which did not quite fit into the Block’s rundown on strategic default risks, suggest foreign entrepreneurs could play a large role with a new type of bank: a lender that specializes in giving new mortgages to high-credit quality borrowers who walked away from an underwater property.
Without legacy assets, the bank would have no fear of encouraging strategic default or cannibalizing its customer base.
“That would really be gasoline on the fire. The main reason why people don’t [walk away] is because they think they will have a very hard time getting a house in the future,” Zingales said. “But if somebody comes and says, ‘You know what, you have always had a good credit, you’re in a bad situation today, I’m sort of going to give you that offer,’ then I think [strategic default] might become irresistible.”
Although Zingales declined to offer any detail on who might be considering such a business idea and noted that it remains purely hypothetical, he said the idea has been floated.
“It makes perfect sense,” he said. “If I am a new lender, that’s the way to do business.”
If it does happen, the fallout could verge on pandemic; Zingales’ latest study indicates that 74% of borrowers consider a good credit score “very important.”
Zach’s blog post from Friday also covered more about strategic defaults – click here.
Which means 24% consider otherwise.
Honestly, someone who walks away from an underwater property probably has more business sense and is much less of a credit risk than the sucker who sticks with it and throws good money out the window.
Correction. 26%.
Bad math. There goes my credit rating! 🙂
A bank with a clean balance sheet lending to home-seekers w/o heavy debt…makes sense but I think the powers that be (i.e. big banks) would squash it
Just think of all the money that becomes available for consumer spending after walking away. There comes a point when these loans are just plain not serviceable. Walking away is just realizing this.
Banks aren’t the losers… taxpayers, savers, your grandkids, etc… THEY are who is really getting screwed by those who default.
Here’s the flaw… any bank that did this would have to be domiciled domestically (at least the lending function would). Which means that it would have to obtain a US banking charter and be subject to US regulations. The regulatory authorities are not going to allow a bank to follow this business plan because on-balance sheet mortgage loans made to folks with low FICO scores generally require a “policy exception.” And there are limits to the total percentage of a bank’s loans that can have such policy exceptions. This is an interesting idea, but I don’t think it’s feasible given the regulatory hurdles.
This business model has been around forever, before Chicago finance professers thought it up. It is called hard money lending.
Borrowers should just expect to put down a large amount of cash so that the lender is protected by the collateral, and don’t expect government subsidized rates,terms and fees.
Kingside, no hard money lender will take on a long-term obligation like a 15- or 30-year mortgage. They don’t have the proper liability structure to finance it. Hard money property loans are generally quickly turned into loans that end up on bank (or government or other institutional) balance sheets. Furthermore, hard money loans are typically underwritten at an interest rate FAR higher than most borrowers are willing to commit to long term.
Any institution that wants to be in this theoretical business will have to be funded by deposits or the spread won’t be there… which gets to the issue of regulation, which I addressed. Looks good on paper, but probably not feasible.
Another recent article on walking away that is a decent read:
http://www.huffingtonpost.com/2010/05/11/jpmorgan-chase-warns-inve_n_571103.html
A particular line in the article stood out to me:
“If the trend continues, strategic defaults could both accelerate the pace of home foreclosures and also make it harder for new borrowers to obtain mortgages. Both factors would in turn worsen the decline in house prices.”
The only question I have is when are these banks going to take a stand and start defending their right to pursue these people for non-purchase money home loans? I suspect that if this trend worsens that the banks will fight back at least if they see something they can go after.
pemeliza,
Can you send me your address so I can get you the t-shirt and Padres tickets you have coming!
Top 10 states with the highest negative equity rates:
1. Nevada: 69.9 percent (418,543 out of 599,128)
2. Arizona: 51.2 percent (690,578 out of 1.3 million)
3. Florida: 47. 7 percent (2.2 million out of 4.5 million)
4. Michigan: 38.6 percent (533,249 out of 1.4 million)
5. California: 34.1 percent (2.3 million out of 6.9 million)
6. Georgia 28.7 percent (457,652 out of 1.6 million)
7. Idaho: 23.7 percent (57,093 out of 240,613)
8. Virginia: 23.6 percent (293,825 out of 1.2 million)
9. Maryland: 22.8 percent (309,568 out of 1.4 million)
10. Utah: 21.1 percent (99,030 out of 470,205)
Pemeliza – take those padre tickets!! Jim was kind enough to offer his seats to us and they are great, even though we were surrounded by Giants fans…however, Eckstein fixed that with a 10th inning walk-off homer against the Western Metals Bldg…
i object to the above obnoxious comment – especially after getting swept yet again by you sunshine boys 🙁
but on topic – i could see 5 or 7 year ARM’s by portfolio lenders with slightly higher rates that strategic defaulters flock to. In time the foreclosure is cleared from your credit report and you re-fi to a 30 yr fixed with a better rate. Those lenders already exist – they just need to allow for lower credit score borrowers.
one of the best peices of advice i heard was to be sure to print out your credit reports and scores BEFORE you walk away – that way you can prove to future employers and landlords that but for one bad financial mistake you are an excellent credit risk