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Slipper Slope for Bagholders of America

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May 01, 2008 – Comments (8)

Great post at Blown Mortgage on the slippery slope of principal reductions at Bagholders of America, and what it means industry wide.

Key question: why will others bother to keep current on their mortgage payments if they know that refusing to pay for long enough will muscle the banks into reducing the principal?

(And let's also ask, why is the government encouraging this behavior by making such reductions tax-free income? And finally, what does this do to real "prices" reported by the RE industry if we know that the numbers those "comps" are built on are bogus, because they don't report principal writedowns made by the banks subsequent to the sale?)

Is Bank of America headed towards principal reductions? [more]

8 Comments – Post Your Own

#1) On May 01, 2008 at 11:22 AM, Evlampius (< 20) wrote:

True, and also lets wait till people figure out that they don't have to pay their credit cards bills either...

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#2) On May 01, 2008 at 11:47 AM, leohaas (32.29) wrote:

Banks will do what is best for banks! If principal reductions are going to help the bottom line of the bank, they will reduce principals.

Look at it from the bank's perspective: If they don't help these "poor homeowners", then the house will go into foreclosure. That takes at least 6 months, during which the soon to be former owner stays in the house without paying the mortgage, without maintaining the house, and upon leaving quite possibly doing some damage. Then the bank finally owns the house which they don't want so they sell at a fire sale price. This results is a relatively low comp in the neighborhood, pushing home prices even further down, and putting more bank customers in the same predicament (no equity, so no way of refinancing, so when the ARM resets another foreclosure). This is the vicious circle a bank wants to break ASAP, especially if they have a lot of customers in the same neighborhood.

Oh, and don't forget that if the bank lowers your pricipal by say $25,000, they get to write that off, resulting in a tax savings over the write-off (this is exactly why the reduction ought to be taxable income for the home owner. I agree with Bent on this issue).

The effect of course is artificially higher prices. As explained above this is exactly what the banks are after. The RE industry will be very happy about that, but from the banks' perspective that is only a side effect.

I disagree with you that this will lead to homeowners in good standing purposely falling behind on their mortgage. I would never even consider this. The risk of ultimately losing the house  and the guarantee of ruining my credit score for the next 10 years as a result of playing this game is not worth it. Nobody with any equity in the house left will do this.

I also disagree that with the article your refer to that this is a "moral" problem. It is not. It is a 100% a financial issue. You are morally obliged to attend church and pay your taxes. The mortgage is something completely different.

For us investors it shows again how dire the situation at the banks is today. I have said it before and say it again: sell any bank stock if you haven't done so, and use any uptick to establish a short position (or buy a put if you are into options trading). 

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#3) On May 01, 2008 at 12:15 PM, DemonDoug (82.77) wrote:

"I disagree with you that this will lead to homeowners in good standing purposely falling behind on their mortgage."

 

I disagree with your disagreement.  Let's say you are current, but barely making your monthly nut - like your mortgage payment is 50% of your gross pay.  You might be current but are in serious danger of falling behind.  You might be thinking about walking anyway because that payment is absolutely killing your life (no money to do anything but to go to work and eat ramen noodles on your granite kitchen table).  So why not just not pay for a while and see if the bank gives you a reduction.

Remember leo many of these fools out there bought houses with expectations of 10-20% appreciation, they are greedy morons who were led by the ear by other greedy morons, and are absolutely shameless when it comes to this type of thing.  (As well they should be - they take their cue from Wall Street and the White House.)

What about all those people that bought 600k mcmansions in subdivisions where those same mcmansions are now going for 300k?  and of course there are all the "investors" out there.

I'm not saying everyone's gonna do it but there will definitely be some people out there trying to do just this, especially if they are underwater on their mortgage.

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#4) On May 01, 2008 at 12:37 PM, FourthAxis (< 20) wrote:

@leohaas  You obviously have scruples, but perhaps lacking on the logic front?  If banks starting "doing what [they think] is best for banks"  consumers will do what's best for consumers and start withholding payments till they too get a renegotiation. 

I mean...if you're a homeowner and you can manage not to spend your withheld payments...you have a LOT of leverage up until the day the sheriff puts you out.  

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#5) On May 01, 2008 at 12:46 PM, FourthAxis (< 20) wrote:

Wow leohass...upon second read. 

"The risk of ultimately losing the house  and the guarantee of ruining my credit score for the next 10 years as a result of playing this game is not worth it."

There is no risk of losing the home...like all negotiantions, it's like a game of chicken.  You can pull the plug at any time and keep paying like good sheeple.

There is no guarantee of ruining your credit either....even if your credit did suffer....wouldn't a 30% discount on your home - thus your payment - be worth it over a 30 year timeframe?  Me thinks so.

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#6) On May 01, 2008 at 1:10 PM, TMFBent (99.82) wrote:

quick note: there's not much of "morality" in "moral hazard." Moral hazard is, at root, a more economic concept, describing the situation that occurs when you reward people for bad economic decisions. Do this and they, of course, engage in that same behavior, rather than changing toward more beneficial behavior.

It's got nothing to do with right and wrong, and everything to do with encouraging decisions that reward successful risk taking.

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#7) On May 01, 2008 at 6:54 PM, FleaBagger (29.74) wrote:

In the meanings of the words "morality," "moral" (as used in "moral hazard" - similar to "morale"), as well as "more" (the one that's pronounced like "moray"), you have behavior and motive. So they're not that unrelated. But the moral hazard issue is distinct from the issue of morality, as Seth said.

Anyway, I remember when I was a kid, I would go to summer camp, and there was this enormous hill where they would set up the Slipper Slope, and we would slide down it, going so fast you wouldn't believe, and there was this one girl that walked by and got totally taken out, which was hilarious, and we all had a blast!

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#8) On May 02, 2008 at 1:17 PM, leohaas (32.29) wrote:

Of course it is possible to game the system. Wherever there is a system, people will figure out how to game it. The question here is, how many will actually engage in this "game of chicken" given the opportunity, but would otherwise have kept on making their payments like everything was hunky-dory. Not too many I would think, but no doubt that BoA will have some ideas on this when they start offering principal reductions to some of their clients.

BoA will remain in the driver's seat on this one. Just because they offered principal reduction to your neighbor, doesn't mean they will offer it to you. Don't count on it to happen if you are one of only a few BoA customers in your neighborhood. And don't count on them to reduce your principal by 6 figures. The McMansions DemonDoug is referring to are a lost cause.

I read the whole thing about the word "moral" three times, and I don't understand it. Especially the reference to the word "morality" since I did not use that word.

I would not have scruples about engaging in this chicken game. I just lack the b@lls. For someone with an 800 credit score, 15 year fixed rate mortgage, and still more than 40% equity in the house it would not make sense anyway. See ForthAxis, there is nothing wrong with my logic either.

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