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Wednesday, October 6, 2010

Why Housing Is Going to Zero


Halting foreclosures due to faulty paperwork -- or even fraud -- is procedurally sound.  However, freezing the foreclosure process will ultimately, and quickly, hurt everyone except the defaulting borrower.
The revelations that banks are not submitting correct or accurate affidavits or otherwise have problems proving that they actually own the house being foreclosed upon are giving politicians  -- like New Jersey's Senator Bob Menendez -- an issue to use for their political advantage and to cast themselves as the defenders of the downtrodden, the victims, if you will. 
The foreclosure freezes, accompanied by a growing reluctance by title insurance companies to issue title insurance on any foreclosed home, threaten to set in motion a series of falling dominoes that will hurt virtually everyone except for deadbeat homeowners.

The current average time between the first payment default and actual eviction is estimated by the Mortgage Bankers Association to be approaching two years.  This means that defaulting homeowners are now able to live, rent free and without paying their property taxes, for that period of time.  At a modest mortgage payment of $2,500 per month, a defaulting homeowner could save close to $60,000 by simply defaulting.
If you ask me, that sounds like a great, tax-free -- and riskless --  return on investment, doesn't it?   Think that doesn't beat the stock market?

From an economic point of view, this makes sense.  Especially in non-recourse states (like New York and New Jersey) where lenders cannot go after borrowers' personal assets.  Why stay current on a declining asset -- whether or not you are underwater -- when you can stop paying, live in the house rent free for years and pocket the difference? 

The extreme moral hazard this situation threatens to create should be obvious.  And the pain is going to be felt by everyone...

First, the banks will suffer losses, both in reality and on paper when they finally have to realize losses on their mortgages they kept on their books.  The banks will seek to recoup those losses from every other aspect of their operations.  That means soaking their other customers.  That means the spread between what they charge you for a loan (or credit card) and what they offer on a bank savings account or certificate of deposit will increase; any fees they can charge will also increase while services will be cut to the bone.  This will hurt every other aspect of the economy, including most businesses. 

Homeowners will be hurt as well.  The value of their properties will decline, because they will have nearby "comparable" homes owned by defaulting "owners" which, due to the foreclosure freeze, will have an effective price of near-zero.  If title insurers will not issue policies on those houses, no future lender will grant a mortgage on the home.  Unless future owners -- and more likely, vulture investors willing to buy for pennies on the dollar -- agree to take the risk that their title will get challenged, that house becomes unsaleable.  In that situation, the bank then has no incentive to foreclose, because taking possession adds responsibilities to the bank but results in no revenue gain.

This is what will happen if you have a neighbor who has defaulted...and is now likely to be allowed to stay in that home rent-free, indefinitely, because his house has become toxic and essentially unsaleable at any price.
Now that there is (at least for the time being) no penalty for default in a non-recourse state, a responsible homeowner has every right to ask why he should still pay his mortgage.

Eric Dixon is a New York small business lawyer and president of Eric Dixon LLC.  Mr. Dixon is a 1994 graduate of Yale Law School and has practiced law for more than 15 years, representing people in litigation, negotiations, government investigations, regulatory investigations and various transactions.  Mr. Dixon also performs strategic analysis, crisis management and litigation stress management for clients.  He is available for consultation or comment at 917-696-2442 and edixon@NYBusinessCounsel.com.


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