Increasingly, homeowners with good credit and no late payments are making what appears to be a strategic decision to walk away when their home’s value falls below what’s owed.

Beth sent me a link to the article on MSN that is the source of the above sentence (The Rich Bail Faster on Mortgages).

More from the article…

The better their credit rating, the more likely homeowners were to default. The trend is most pronounced where prices have fallen furthest: Florida and the West, especially California.

What’s astonishing (maybe it shouldn’t be) is that lots of these homeowners can AFFORD their payments but are choosing to default because their home is worth less than what they owe.

The article mentions that walking away from a debt was taboo in the past. I think people are doing it now because they look around and they see everyone else getting bailed out and figure, “What the hell…I’ll do it too.” You can’t tell me that when you look around and see banks getting bailed out (while still paying themselves bonuses) and strapped homeowners getting bailed out, that it doesn’t affect the way you see things.

Does that make it right to walk away from an obligation even though you can afford to pay? NOPE! Such behavior—whether ’strategic’ or not—is shameful. Why don’t they do the same thing with their cars? If you buy a new car with a loan, you are underwater the second you drive that car off the lot. Does that mean you should walk away from the car? Why is a house any different—aside from the fact that we were led to believe that housing prices always go up?

Sorry for the rant. It’s all Beth’s fault!

The number of workers taking part-time jobs due to the slack economy, a kind of stealth underemployment, has doubled in this recession to about nine million, or 5.8% of the work force. Add those whose hours have been cut to those who cannot find a full-time job and the total unemployed rises to 16.5%, putting the number of involuntarily idle in the range of 25 million.

I don’t think you can count part-timers as being unemployed. Sure, they may prefer to be full-time employees, but they are still employed.

Regardless, his other nine points make sense and the bigger picture of his piece is that the government disguised congressional wish lists as stimulus. In other words, we are spending all this money and it’s not going to do what they promised us it would do and that’s create jobs.

NEW YORK, July 14 (Reuters) – U.S. government officials are weighing a plan that would let borrowers who have fallen behind on their mortgage payments avoid eviction by renting their homes instead, sources familiar with the administration’s thinking said on Tuesday.

Under one idea being discussed, delinquent homeowners would surrender ownership of their homes but would continue to live in the property for several years, the sources told Reuters.

Officials are also considering whether the government should make mortgage payments on behalf of borrowers who cannot keep up with their home loans, tapping an unused portion of a $50 billion housing aid kitty.

As part of this plan, jobless borrowers might receive a housing stipend along with regular unemployment benefits, the sources said. (Reporting by Patrick Rucker; Editing by Diane Craft)

This is taking government housing to a whole new level. It also raises a whole bunch of questions:

• What would be the implications of such a plan?

• Does the government continue to pay the mortgage?

• What happens after several years of the former homeowner paying rent? Do they get to buy the house back? For what price?

• What if they can’t afford the rent?

• Where does it end?

Despite what some of the negative reviewers say about the book on Amazon, this is a great book. Some of the Amazon reviewers gave it a one star because too many other people gave it a 5-star! Others said things like, “Nothing new here.” Well, it’s supposed to be an account of what happened—a historical book. Anyway, I thought David did a great job of condensing the events that led up to the subprime mortgage crisis into a book that is actually enjoyable to read. I found myself underlining lots of passages and adding notes like, “WOW!” and, “This is crazy!” I even stopped several times and read things to my wife—something I don’t do very often.

The book opens with a discussion of how Federal Reserve’s reaction to the Technology Bubble’s bursting and 911 led to low interest rates for far too long, which spawned the housing bubble. In other words, cheap money played a significant role in creating the subprime crisis. It is amazing how one thing leads to another. With the subprime crisis, you could almost see the progression of events.

The book begins with the bursting of the technology/internet bubble and the Fed’s reaction to both that and 9/11. Remember, the Fed uses to the Fed Funds Rate to stimulate and to cool the economy. The Fed had driven up the Fed Funds Rate to 6.5% at the time the NASDAQ was peaking in March 2000 and in response to the bubble bursting, drove them back down to 3.5% by September 2001. Then, in reaction to 9/11, the Fed took the following actions:

These lower rates, which affected mortgage rates, inspired people to refinance their homes in record numbers. As the author points out, some people were refinancing to get a lower interest rate and a lower payment. Others were refinancing and taking their home’s equity and using it to buy things.

All this cheap money also meant that fixed income investors weren’t making very much money. This led Wall Street to look for other ways to find yield, which they found in the bundling of mortgages into Collateralized Debt Obligations (CDOs). NOTE: I’m summarizing here so I’m leaving out a lot of details which you can find in the book. These CDOs were sold all over the world to yield-hungry investors.

Wall Street’s demand for mortgage-back CDOs inspired mortgage brokers to make more loans. Why? Because these brokers were assured of a buyer for any mortgage they wrote. It was to their benefit to write as many mortgages as possible without any consideration to the buyer’s ability to actually pay the mortgage beyond 90 days (according to the book, the mortgage broker faced losses if the buyer defaulted within the first 90 days of the mortgage).

Competition among mortgage brokers and bankers drove standards downward. Mortgage seekers could get by merely stating their income. They could also get a mortgage for 95% to 100% of the purchase price of the home, which was unheard of just a few years before. They were also using all sorts of different loans in order to purchase their homes. By 2006, 40% of all loans made were of the subprime and alt-A category, which are much riskier than a traditional prime mortgage.

People were also using adjustable-rate mortgages and other mortgages with low teaser rates that adjusted upward after a couple of years. Of course, all this action drove housing prices skyward. People had no fear of their mortgages adjusting upward because if they did, they would just refinance into a newer mortgage and get their payments back down to a manageable level.

Those were the main characters in the mortgage crisis but the book also describes other characters who played significant roles.

• The rating agencies that blessed some of the mortgage-backed CDOs with AAA ratings even though they were loaded with subrpime mortgages. Unsuspecting investors purchased these AAA rated securities, thinking they were getting a safe investment. WRONG!

• AIG, which insured a lot of CDOs but didn’t have the necessary reserves to cover all the claims.

7bull; The Fed turning a blind eye to what was going on. Greenspan claims there was nothing he could have done to prevent the crisis or that the prevention of the crisis would have been worse. Who knows…

Like I said earlier, I greatly summarized the events and characters of the subprime crisis. For more detail—but not too much to bog you down—read And Then the Roof Caved In*. If you’re like me, you’ll find yourself scratching your head in amazement at how all this was able to take place.

GIVEAWAY…

Now, for those of you who made it all the way through my review, I’d like to give you the opportunity to win a copy of the book (on me). All you have to do is leave a comment. I will select one commenter and send them a copy of And Then the Roof Caved In*. Just remember my two rules (yes they are the same two rules I have always had):

1. You must be a resident of the USA or Canada (I won’t mail internationally).

2. You can only enter one time.

Good luck and thanks for reading!

*Affiliate Link

For the two-thirds of American families who own their homes, a house is their biggest asset. The lower house prices go, the less wealthy they are and the less they can or will spend and borrow. For home builders, the lower home prices go, the fewer new homes they will build and the fewer workers they will hire. And for many American banks and other financial institutions, mortgages, mortgage-backed securities and financial instruments that rest on mortgages remain a huge headache. The lower house prices go, the less these loans and investments are worth and the weaker the foundations of the financial system are.

Although I understand the importance of housing prices, I’m concerned that as a nation we will return to our former ways of using home equity as a piggy bank for consumer spending. From what I have read it’s clear to me that that was what led us to this predicament in the first place.

I guess my real question is…

What’s to stop this from happening all over again?

I mean, we have laws against fraud, but they weren’t enforced when people lied about their income in order to get bigger mortgages. What’s to stop this from happening again? Clearly we can’t rely on homeowners or potential homeowners to not take on too much debt. Nor can we rely the ethics of the mortgage brokers and bankers to not allow customers to take on more debt than they can handle since they [the mortgage brokers and bankers] are worried about the potential customer getting financing from a competitor.

I’m also concerned that so much focus is placed on consumer spending. Yes, we need consumer spending but shouldn’t we be more concerned with the incomes necessary to support that spending? We saw in the last eight years that consumers were simply borrowing money in order to spend.

Maybe we should have some standards in place. Things like…

• No more than 30 – 35% of your income should be spent on housing.

• Your income MUST BE VERIFIED!

• You need at least a 10% down payment when purchasing a house.

• No more than 80% (or maybe even less) of your equity can be withdrawn via a home-equity loan.

I would even like to see new homeowners attending homeownership classes or something of that nature. Purchasing a home is a HUGE decision and people should be getting their education from someone other than those who stand to gain from their decision.

Those are my thoughts? Do you have anything you’d like to add?

Here’s the deal:

Overstating your income (lying) on a loan constitutes fraud. Fraud is punishable by law.

I haven’t found any hard numbers on how many stated income loans were used or how many of the stated income loans were overstated. But, it shouldn’t have been that hard to figure out. If you say you make $16,000 a month and in reality only make $3,600 per month (an example in the book), it wouldn’t take long for that overstatement to come to light. All one would have to do is find the paperwork and then compare that to tax returns. And, this could be done by those who are helping people stay in their homes.

Unfortunately, prosecuting the fraudsters would most likely be an expensive process.

I’m not against helping those who LEGITIMATELY need help. I just don’t like the idea of helping those who might have committed fraud.

Just think, this entire crisis probably could have been averted had lenders insisted on income verification!

As my regular readers know, I have blogged a lot about the subprime mortgage crisis. In one of my posts, I mentioned that brokers were incentivized to put prime borrowers into subprime products. One of my commenters (mortgage broker I believe) argued that brokers were not given incentives to promote one type of mortgage over another. Well, unless David Faber is lying, on page 71 he writes that some brokers WERE given incentives (emphasis mine):

The higher the rate on the mortgage, the more money the originator would be paid in that rebate** by Wall Street. “If you could sell the loan for a highter rate and sell a lot of them at a higher rate, the Wall Street was in love with you. They would bend over backwards for you. They would buy anything you’d give ‘em, just about,” gushed [Lou] Pacific. Subprime loans carried a low initial rate, but over the life of the loan a very high rate. It proved to be the perfect product for Wall Street. It also proved tempting for many of the subprime firms to convince consumers to take a subprime loan even if they qualified for a much lower-priced prime loan. “We used to get an awful lot of them [prime borrowers],” say Pacific unapologetically. “They were more concerned with the pseed of getting a loan. And plust the average person doesn’t understand where their credit ranking is, some don’t think they can qualify for a good loan, but they can. So0 they’ll call and if you sell a loan with a higher FICO score, you’re going to make more money on it.” Pacific claims that when he encountered such a person he would refuse his business and tell him to go to his local bank.

Yeah, right. I’m sure Mr. Pacific turned the business away. He may have, I don’t know. Let’s just say I’m skeptical.

Of course, the AFM commenter may not have been given incentives if he worked for a smaller firm that didn’t have a direct relationship with Wall Street. I suppose that is possible.

I encourage you to pick up a copy of David Faber’s And Then the Roof Caved In*. It’s a page-turner as David does an excellent job of explaining the story in a way that most people can understand it. I’ll be mentioning more tidbits from the book in the near future.

*Affilitate Link
**Also known as a yield spread premium.

By the end of 2008, households were on the hook for $13.8 trillion in debt — nearly matching the $14.3 trillion output of the entire U.S. economy, not adjusted for inflation, that year.

Households are shedding debt; they’re just not doing it very quickly. They owed roughly 130% of disposable income at the end of 2008, down only slightly from a record 133% in the first quarter of 2008.

An old saw about U.S. consumers is never to underestimate their willingness to spend beyond their means. The debt-to-income ratio first crossed 100% during the 2001 recession, when debt-fueled consumer spending helped spark a recovery. It kept rising post-recession as super-low interest rates encouraged still more borrowing. And it rose even after the Fed raised rates, as consumers piled into mortgages to chase rising home prices.

The recovery we experienced after the 2001 recession was built on sand (consumers taking on more debt than they could handle).

Is it just me or does it seem like the fundamentals of personal finance are being completely ignored? How can we realistically expect a recovery if the fundamentals are all wrong? It seems like we all want a recovery but nobody wants to make the hard choices and take the hard actions. Instead we act as if we can cover this up with bailouts and everything will be peachy.

Long-term I’m an optimist. Short-term I’m scratching my head.

The article seems pretty clear that Mozilo was aware of just how bad things were while he was dumping his company stock. Mozilo had always played the “I-don’t-know-how-this-could-have-happened” card. I remember reading in the Wall Street Journal (I can’t remember which article exactly) Mozilo saying something like, “No one could have seen this coming.”

Sure, pal.

Assuming that these charges hold up and Mozilo is convicted, what do you think should happen to him? What would be considered justice in your opinion?

I think he should be stripped of all his worldly possessions and wealth. If he were younger, I’d make him lay railroad tracks or fill potholes on America’s crumbling highways…lol.

The charges the SEC is considering include alleged violations of insider-trading laws and alleged failure to disclose material information to shareholders, according to people familiar with the matter.

Mr. Mozilo sold $130 million of Countrywide stock in the first half of 2007 under an executive sales plan, according to securities filings, compared with $60 million in the year-earlier period. He had modified his prearranged plan in late 2006 to accelerate the sales.

So, here’s today’s Question of the Day:

Do you think the SEC should be charging Mozilo with fraud or do you think they are just looking for a reason to can this guy because of who he is?

My thoughts:

I think the last sentence of the last paragraph in the quote from the Wall Street Journal makes him look very suspicious. Take a look at this one-year chart I found at SeekingAlfa:

So Mozilo was making arrangements in 2006 so that he could accelerate his stock sales? Looks suspicious to me. I’m not quite sure how this could be construed as insider-trading though. Was he using insider information for his own benefit? I mean we all knew what was coming. We all knew that giving loans to people who couldn’t afford to pay them back was going to lead to serious trouble. We all knew this.