I think they did a good job explaining why borrowers will just send in their jingle mail and low rates won't make a bit of difference:
Over the next several months, we're going to be subjected to a chorus of hand-wringing about the moral turpitude of people who walk away from their mortgages and pronouncements like last month's warning from Treasury Secretary Henry Paulson that people should honor their mortgage obligations. The problem with finger-wagging on what you "should" or "ought" to do is that, when it comes to money, you're usually given the lecture only when it's in your interest to do the opposite. Certainly, that's the case for all the California homeowners who in the next year or two are going to find themselves with the choice of whether, faced with a huge new wave of interest resets and a historic decline in the value of their homes, they will simply walk away.
Unfortunately, when it comes to the California crash, these striking numbers are not the end. They are the beginning. (To give Paulson his due, he said that, too.) Which brings us to the other scary part of the California story: a coming wave of interest-rate resets in prime loans given to people with good credit that are just as bad, or worse, than we've seen in subprime.
The most common subprime loans were known as "2/28" in the industry: 30 years, including a two-year teaser rate before the interest rate rose. Now these loans have reset, and we're seeing the fallout.
But prime borrowers, too, got loans that started out with low payments; if you bought or refinanced your house in the last few years, it's not unlikely that you have one. With an "option ARM" loan you have the "option" (which most borrowers happily take) of paying less than the interest; the magic of "negative amortization." The loan grows until you hit a specified point—the exact point varies with the lender; with Countrywide, it'll come after about four and a half years—when the payment resets to close to twice where it was on Day 1.
Just two banks, Washington Mutual and Countrywide, wrote more than $300 billion worth of option ARMs in the three years from 2005 to 2007, concentrated in California. Others—IndyMac, Golden West (the creator of the option ARM, and now a part of Wachovia)—wrote many billions more. The really amazing thing is that the meltdown in California is already happening and virtually none of these loans have yet reset.
Option ARM loans were heavily marketed to upper-tier home buyers in California. It's hard to know how bad the option ARM crisis will be before it actually happens, but Moe Bedard, an advocate in Southern California who advises homeowners on foreclosure and blogs about the crisis at Loansafe.org says that the difference in the time until the rate rises is the main reason that upper-middle-class Orange County (now facing foreclosures at a rate merely twice the national average) hasn't yet been hit as badly as places like Riverside.
When those dominoes start falling next year, we may or may not have a subprime bailout plan, and the discussion will start about how to bail out this next tranche of borrowers. The bailout plans on the table now, such as the one put forward by Barney Frank (one of Congress' genuinely cogent financial minds), are reasonably based on the principle of bringing payments down to a point that homeowners can afford.
But where prices fall 40 percent to 60 percent, all that goes out the window. Why? Because in expensive locales like San Diego, tens of thousands of people with 100 percent loan-to-value mortgages and option ARMs are living in homes in which they have no equity and on which they owe a lot more than the house is worth.
In these places, accepting a government "bailout" that pays them, say, 90 percent of the value of the house to keep from foreclosing will be very tough for lenders, who (if the appraisers don't fudge the numbers) could be forced to take 36 cents or 45 cents on the dollar for their loans. On the other hand, any plan that makes them pay more if they can afford it is hugely disadvantageous for the borrowers, who have option ARMs about to reset and are much better off handing the keys to bank—and maybe even scooping up the foreclosed house down the street.
If you're one of the "homedebtors" (a fantastic neologism coined by the anonymous blogger IrvineRenter on the Irvine Housing Blog) in this position, you might start thinking very seriously about just how attached you are to the wisteria vine snaking over the basketball hoop on your garage. That's what a lot of other California borrowers will be doing.
The luckiest of those are the ones who used option ARMs to buy a house. For them, walking away is easy: Their loans are "nonrecourse," and the lenders can't go after them for more than the value of the house. The choice is harder for those who used the loans to refinance. The quirks of real-estate law regarding refi loans make it possible (though not necessarily easy) for lenders to try to get back more money even after taking the house.
If you think, however, that should make lenders a lot happier, forget it. LoanSafe's Bedard says that even in this group, most of the option ARM borrowers he talks to—some of them living in $800,000 houses—are already considering walking away from their deeply depreciated homes as soon as the rates reset.
Bet on this: Whatever moral qualms are being urged on borrowers to keep them from walking away from their mortgages, they'll count for a lot less than the economic reality facing borrowers whose homes have fallen in value by half. Lenders had no reservations about selling borrowers loans with rising payments that would be poisonous in a rising market. Now it seems borrowers have no reservations about leaving those lenders with the risks they begged to take.
Consider, too, that, yes, going through a foreclosure kills your credit rating and makes it a lot harder to buy a new house—but as more and more prime borrowers go into foreclosure, it's perfectly possible that buying a new home a year later will in the near future be as routine and unsurprising as the once inconceivable idea that you can get a whole batch of new credit cards two years after a bankruptcy.
Of course, all those people stuck between rising mortgages and falling prices are free to follow Paulson's advice: Keep making payments on an outsized mortgage, and take a bullet for the greater economic good. Fortunately for them, and perhaps unfortunately for the economy, a lot of them will come to the realization that they just don't have to.
Also, Mish covered the topic last year and had an excellent analysis of the moral equation behind "walking away":
Avalon writes: "Mish, I'm very disappointed that you don't think people are morally obligated to try to honor their agreements. Just because it's legal doesn't make it right."
Let's explore the issue of moral obligation with a series of questions.
* Where was the moral obligation of those willing to lend money to someone who they knew could not possibly afford the house?
* Where was the moral obligation of those willing to lend money to someone when the lender did not care how overpriced the home was?
* Where was the moral obligation of those willing to lend money to someone when the lender explicitly knew how overpriced the home was?
* What are the moral obligations homeowners to provide for their family the best legal means they can?
* Suppose someone could "afford" to make payments but at the expense of say health insurance or better schools? What's the moral obligation on that person?
* Does moral obligation only run in one direction?
* Should someone have a moral obligation if he signs a contract with a thief?
National Referendum On Walking Away
Most don't realize it but there is currently a national referendum on walking away that is page one news every single day. I am talking about decision 2008, the presidential election.
Will we walk away from Iraq or not?
* A vote for John McCain is a vote for the status quo of wasting trillions more dollars and countless more lives in Iraq.
* A Vote for Obama is a vote for exiting that hellhole and having discussions with Iran.
* A vote for Hillary Clinton is a vote for wishy washiness, political expediency, and the same stubborn unwillingness to admit mistakes that we see in Bush.
The moral obligations of walking away from Iraq
* Do we have a moral obligation to spend money in Iraq after we blew it to smithereens?
* Do we have a moral obligation to admit mistakes and stop wasting lives of soldiers?
* Do we have a moral obligation to repair the decaying infrastructure of the US instead of attempting to be the world's policeman?
* Do we have a moral obligation to the Citizens of the US to get out of the region, given that being in the region dramatically escalates the risk of terrorism against the US?
* Do we have a moral obligation to stop wasting billions of dollars in jet fuel flying needless missions all over the world when crude oil prices are so high?
* Is there a moral obligation to let Europe and Japan defend themselves rather than depending on US overseas bases and US taxpayer dollars to defend them?
* Is there a moral obligation for the US to walks away from Europe and Japan with so many suffering here?
A discussion of moral obligations in terms of walking away is not as easy as it might have seemed at first glance. There are many questions but no consensus answers. That’s because moral obligations of walking away go far beyond signing on the dotted line. Where people "draw the line" on walking away is going to play a major role in determining the next president of the United States.
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