Blaming Borrowers for Real Estate Foreclosures
The NY Times has a piece out this week titled Borrowers Refuse to Pay Billions in Home Equity Loans that has some really choice quotes from frustrated lenders. The piece is written from the perspective of lenders who are dealing with extraordinarily high levels of home foreclosures. They’re not happy.
Here’s an example quote:
“When houses were doubling in value, mom and pop making $80,000 a year were taking out $300,000 home equity loans for new cars and boats,” said Christopher A. Combs, a real estate lawyer here, where the problem is especially pronounced. “Their chances are pretty good of walking away and not having the bank collect.”
That sounds pretty balanced. The lending market was certainly irrational. However, Combs loses me with his next quote within the piece:
Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar. “People got 90 cents for free,” Mr. Combs said. “It rewards immorality, to some extent.”
I have a lot of problems with that quote.
1. Mr. Combs, the people foreclosed upon don’t have 90% of a house to show for it. They have no house. Working off the $300k figure you used, they probably paid around $1900/month on a second mortgage for years, fell behind, lost their house and ruined their credit.
2. Mr. Combs, lenders were so greedy (or incompetent, or both) that they were willing to offer loans to people who were not in a position to repay them. While you seem to prefer to blame the victim, I would hope that you’d understand that the lends had the information advantage. People working in lending on a daily basis convinced borrowers to take loans they had little chance of repaying. Would you, personally, have lent $300,000 of your own money to someone making $80,000/yr to pay for recreational toys? My guess is, probably not. So you understand the risk that these loans would default, yet you still blame the victims.
3. Mr. Combs, if you were a bit more introspective in your take on the hosed up lending scene, I would expect to see a quote more like this: “We lent money to people who had little chance of repaying it. It turns out that they couldn’t (but we got paid when we convinced them they could!). Now we’re recouping 10 cents on the dollar from this crap that we sold to people. We really were that stupid.”
4. Mr. Combs, borrowers screwed up by overextending themselves, but borrowers know less about lending than . . . lenders. If you’re looking for one person to blame for the high levels of defaults, I think you really need to consider looking at who had the information advantage in this market, abused it, and is not blaming the victims. Find yourself a mirror.
August 12th, 2010 at 4:02 pm
Having worked in the lending industry myself, I can understand where the banks’ frustration comes from. However, in contexts such as this, the so-called financial experts talk about borrowers who walk away from their obligations as if that’s the only time in the entire financial industry that such a thing happens.
Large corporations restructure their debt for pennies on the dollar through chapter 11 bankruptcy all the time. Also, let’s hypothesize, Ed, that you and I are prominent shareholders of a large corporation. That corporation made a financial commitment to another entity under the assumption that there would be a certain return on the investment or at least a value in equity. If neither of these things are happening, and if they are NOT expected to happen in the near future, then we as shareholders would expect our corporation to essentially walk away from that obligation.
Make no mistake, I find walking away from mortgages to be rather distasteful. But I don’t see that as a moral flaw unique to underwater homeowners.
August 12th, 2010 at 4:12 pm
Bravo, Ed!
August 13th, 2010 at 8:54 am
Ed, i like your attitude but your math is mistaken. If you took out a $300K Home equity loan and dont pay it back, you’re still ahead of the game even if you lost your house.
in order for you to not be ahead of the game you need to have paid, to use your numbers, $1.9K a month for 150 months or so just to get to $300K.
People didnt lose the equity on the house. They spent it. Take me, for example, i didnt take a home equity loan and still lost my equity -on paper anyway- At least if i took out a loan to buy a boat and a fancy car i could keep those under current bankruptcy law. I can always get a new home in 1 or 2 years… and likely again with 3.5% down via an FHA loan.
August 13th, 2010 at 9:35 am
@Moroco, great point. That does create some interesting scenarios. Are people who’ve lost their house living in their cars or boats now?
August 13th, 2010 at 10:05 am
they are renting, for 1 or 2 years and then buying a new house.
or do you have to own a home to have a roof over your head?
crap… if they kept their income levels they might be able to afford a bigger home now…
August 13th, 2010 at 10:05 am
missed the quotes around “afford”… sorry
August 13th, 2010 at 10:54 am
@Moroco, that is pretty amazing. It makes me wonder how stupid lenders must be to lend money to people that are such horrible credit risks. As I mention in the post, lenders have the information advantage, due to working in the field on a daily basis. Or, is it a case of loan officers getting paid, but carrying none of the risk themselves, so they’re willing to offer even more financing to people who’ve walked away from hundreds of thousands only a few years before?
August 13th, 2010 at 2:53 pm
ed, you and i and 99% of the people in this country are part of the creative/destructive process of capitalism. Most lenders sold the loans on wall street, so the reality of it is that lenders arent taking the risk.
so perhaps the real crime here is that the smart souvereign (sp?) countries, school districts, pension funds, you and i through your 401k mutual funds etc… people and entities whose money is managed by “smart” highly compensated individuals underwrote that risk and lost a ton of dough.
the stupidity isnt in making that loan. the brilliance is in convincing someone else to take the risk while they took their fee.
August 13th, 2010 at 3:28 pm
@Moroco, if lenders lend money to people who can’t afford it, then offload the loans by bundling them into complex derivatives designed to mislead investors into the security of the underlying assets, is considered brilliance, I think you use the term brilliance where I’d use the term fraud. I realize there are quite a few layers in between the person who sold the home owners on the loan and the person who sold the pension fund on buying bundles of crappy loans, but I don’t see the brilliance in there.
Brilliance, in my book, involves creating value, not stripping it from home owners and pension funds.
Maybe I’m misguided here, but doesn’t capitalism still work if the parties involved in a transaction are honest with each other about what they’re buying and selling? It seems like it takes lies to convince people to buy things that have no value. That’s not brilliant.
I’m curious: do you think lending would still happen if lenders had to hold onto some of the risk? What if they had to hold a few percent of every loan they offered? Would they still make the same loans? That seems like the kind of thing that could have kept the real estate market a bit more sane and sober.
August 13th, 2010 at 4:48 pm
Lenders do NOT have the information advantage.
The borrower spends YEARS thinking about how much home they can afford. They have ALL the information. They know better than anybody what they’re expected future income might be.
The only information the lender has comes from maybe a half-hour meeting and a credit score. Sure they know the industry, but so what? It’s not complicated, it’s simple arithmetic. Does income exceed expenses? You don’t need to be a pro to figure that out.
You’re whole argument rests on this point, and you couldn’t be more wrong. You’re just apologizing for bad behavior.
Not that I feel sorry for the banks that are getting hit. I don’t feel sorry for either party. The only people I feel sorry for are the responsible people who DIDN’T buy more home than they could afford. They’re going to get killed by inflation. And the responsible banks, who should have taken over the market rather than watch the big-time gamblers get bailed out.
August 13th, 2010 at 11:23 pm
@Kpres, I’m having a hard time understanding your logic. Borrowers can spend years thinking about how much they can afford, but it’s the lenders who decide how much they’re willing to lend to the borrowers. In some cases, borrowers may believe that they could handle larger loans, but in cases like the real estate bubble, we saw lenders lending borrowers amounts well beyond what the borrowers would likely be able to pay off. In fact, the only way many of the loans had a shot of not going bad was if the market continued to grow rapidly enough that borrowers could escape their crappy loans with even crappier ones through refinancing.
Lenders who only had a 1/2 hour meeting and a credit score sound like lenders who were doing no-doc or “liar loans” where no proof of income was required by the lender. It seems like the information advantage, in that case, was conceivably in the hands of the borrowers, but that was because the lenders chose not to verify income. Clearly, a full credit report would show how many lines of credit a person has and how much they owe on each loan. And they would normally ask for some income verification such as a W2 or tax return.
So, you’re right that my whole argument rests on this point, and I believe my point is correct. The information advantage falls to so-called professionals over irrationally exuberant consumers.
Note that I’m not saying that the borrowers are without blame. I’m saying that borrowers wouldn’t have borrowed money on such crappy terms if lenders didn’t get into the business of selling crap (then complaining when the crap started to stink and turned into 10 cents on the dollar crap).
August 14th, 2010 at 7:08 pm
Its your blog and you’re entitled to the last word. Call it what you will.
Every body takes advantage of the market one way or another. And yes, i used brilliance with a hint of sarcasm. Maybe it would have worked better if i wrote in italics.
Lending is an art, not a science. It is still predicated in that old fashioned promise to pay. It is still predicated people doing the “right thing” and knowing their limits. However, our wants are bigger than our needs, our eyes bigger than our stomachs. Its been going on since the beginning of time and it will continue to go on one way or another. The interesting thing of the housing market is that we as a country assume that everyone is better off owning a home. Maybe what you’re saying is that we arent. You might say lenders lent to someone they knew couldnt pay. It is a comment made based on your faulty assumption that lenders have the info advantage. I am with Kpres on that one.
August 14th, 2010 at 9:20 pm
@Moroco, let me preface this by saying that I’ve been working up moving this blog to a new server this weekend, so your comment may have been placed without seeing my response to Kpres.
I agree that everyone tries to take advantage of the market. People on both sides of a transaction will often attempt to push things as far as they can in their favor. However, looking at what happened in the lending industry, I see a case where lenders decided to loosen and loosen and loosen their requirements for loans, which is what created a market for consumers that previously did not exist. Yes, consumers took advantage of this, but it was lenders who decided that consumers didn’t have to document their income, have a reasonable credit score, put any money down, etc. in order to be lent money. Clearly, in my opinion, the people with the money set the rules, and they were willing to loosen the rules. And now they’re seeing the fallout from their short term gains.
I’m really interested in learning more about your perspective on this. If you have the time and are willing to share, could you explain to me why a lender was willing to lend hundreds of thousands of dollars to people without even bothering to ask for proof of income (W-2 or tax return)? To me, no-doc loans seem like a case of lenders taking a “dont’ ask, don’t tell” policy toward people with no income.
I think you’re right that America has a fixation with home ownership. However, that doesn’t mean that every American can have their dream home regardless of credit rating or income. Many people are better off owning a home than not, if the house is priced right, the financing is right, they plan to live in it for a while, etc. The lending industry profited from the irrational by ignoring reality.
August 15th, 2010 at 2:29 am
I think you folks are missing a salient point here in your arguments on all sides.
Many loans were given to people at interest rates that changed under some fairly obscure circumstances, and were often unknown to the buyers (yes, they had the docs- have you ever tried to read them? Unless you are a professional in either finance or real estate you probably can be easily tricked).
Often people were assured verbally at closings about clauses that were not present in earlier forms of the documents. Lawyers are rarely used by first/second time home buyers as well.
There were many reasons this crisis happened. Blaming people that merely wanted a chance to purchase a home and couldn’t make it during tough economic times is a 2 dimensional view of the situation.
August 16th, 2010 at 3:33 pm
Gee, Deets, you a Democrat and a Liberal? It seems the whole point of your little polemic has been to absolve the borrower. Why shouldn’t the greedy little pigs hold some blame for their actions. Serious stupidity came over them, and they deserve a kick in the nards for being so dumb.
August 16th, 2010 at 4:00 pm
@Bill, great points. A lot of this did reach fraudulent proportions.
@Hagbard, I don’t believe I was absolving the buyer in this situation. I believe I was saying that the people with the information advantage – the lenders – got into the business of lending money to people who couldn’t afford it, and are now whining that people who couldn’t afford it . . . couldn’t afford it. Borrowers will be as stupid as lenders let them. If lenders didn’t lend beyond what borrowers could afford, lenders would see many fewer defaults. Borrowers were not in a position to force lenders to lend money on ridiculous terms to people with a poor track record of paying their debts. Lenders took extraordinary risks with sub-prime borrowers and lost.
Putting it in your terms, if the borrowers deserve a kick in the nards, the people who lent them money should have their nards cut off for being so stupid.