By Francis M. Miller
Special to InsideRealEstateNews
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A freelance columnist, Mary Winter, writing in the Sunday Denver Post, questioned why more people aren’t walking away from mortgages on their upside down homes.
Without a doubt there are many situations where many people are upside down, or underwater, on their mortgages. That is, their mortgages are worth more than their homes.
There are numerous areas in Douglas County, where I live, for example, such as Franktown, where housing values have dropped 20 percent, according to the assessor’s office. A recent study of residential equity revealed average equity countywide was less than 15 percent before the collapse of the market. Many homeowners are 5 percent to 15 percent upside down, representing a crisis on a $1 million dollar home when divorce, death or job loss occurs.
A quick spreadsheet analysis of trends would suggest this problem will grow and intensify, particularly for ex-urban homeowners with horse properties and McMansions.
Many people would have to go to closing with tens of thousands of dollars just to get out from under their current property.
They would end up renting for many years to recover sufficiently to re-enter the market. Many people are seriously beginning to consider buying a smaller property and walking on the mortgage on the larger property.
Dark side to walking away
Despite the dire housing market, in my mind there is a dark side to what the Mary Winters of the world would like to portray as a rational economic analysis.
It all boils down to integrity.
Integrity is doing what you say, both in terms of your explicit contracts and implied social contracts. It is just such an implied social contract that motivates soldiers to risk their lives to recover their buddy’s body from the battlefield.
The self-interested, profit-maximizing borrower who is upside down can always rationalize that it was the money-changer lenders who caused this problem and brought us all to the brink of disaster.
The borrower can do a cost-benefits analysis and quickly conclude that he or she would be better off by walking away.
But, the mere act of doing such a cost benefit analysis, instead of just doing what had been agreed to, demonstrates a de facto lack of integrity, regardless of what the analysis might reveal. I’m not talking about morals or ethics or religion. I’m talking about raw, old-fashioned integrity – the act of doing what you said you were going to do– nothing less.
If you have integrity, you don’t need to waste your time doing cost-benefits analyses. If you have integrity, you don’t rationalize your bad behavior because the lender is a snake or the government sanctions weaseling out of the deal. You do the right thing because you have integrity.
Calculations don’t factor in ethics
Every day you and I run into people whose integrity is conditionally dependent on the latest spreadsheet cost-benefits analysis.
The calculus on integrity is rampant in mercantile affairs where defaulting, backing out, or stabbing someone in the back is merely “doing-business.” When we find ourselves in the midst of such a situation you and I are afforded a golden opportunity to declare to the world who we really are.
If we personally chose to do something that is immoral, unethical and maybe even illegal all the while calculating the probability of whether we will get caught, then we have tossed our integrity to the four winds. Trying to shore up our decision with some rationalization or cost-benefit analysis is all the more pathetic.
Sure, lacking integrity, like crime, can sometimes pay.
Some people live out their entire lives, become massively wealthy and display little integrity. They live in the shadows. A real estate deal goes bad and they collapse the limited liability corporation that was the actual owner. The bank fails to turn a profit and they let the regulators take it over and sell it off to some out-of-state buyer.
Still, there are a few – decried as throwbacks to the dinosaur age – who will die as a pauper, but are iron-willed when it comes to displaying integrity. Many of us do the proverbial cost-benefit analysis to see what we can get away with and what we can justify. If we can weasel out of the deal we’ll do it. When such behavior begins to occur on a mass scale, it is hard to see how our social-economy can function. The credit markets will never be robust again without government intervention. Government programs create a cascade of unintended consequences. I assert that personal integrity is a thing of intrinsic worth and the need for it never changes, no matter how many spreadsheet programs exist.
Don’t get me wrong. I’m not lending lenders off the hook, either. Let me give you a real life example of a real estate deal my wife and I are trying to consummate right now.
We want to relocate my wife’s psychology practice of 25 years to Lone Tree. We have identified the perfect property, a 1,200-square-foot office condo that is for sale. What astounds me that the current seller is upside down, but she has had the integrity to continue making her mortgage payments.
It has caused a real hardship for her and her family and it is not her fault that the lending industry allowed overbuilding and a crash that decimated property values.
She is being punished by the likes of JP Morgan/Chase, even though a qualified buyer (my wife and me) wants to buy the property. The lender will not allow the current loan to be assumed and they insist on a new loan with a new appraisal and a 20 percent down payment. We can handle the 20 percent down, but the gap between the lendable value and the payoff on the seller’s current mortgage is a chasm that neither the current owner nor we can cross. Forget that during the past five years JP Morgan/Chase has collected $25,000 a year, largely for interest payments. Forget that JP Morgan/Chase would have a new borrower with impeccable credentials going forward. JP Morgan/Chase stubbornly insists that they will not entertain a short sale and that unless the current mortgage holder quits making payments and creates a default situation, there is nothing they can do.
Obviously, identifying people with integrity takes a face-to-face meeting. That’s why I believe all the computer credit scoring in the world will never be a substitute for a seasoned loan officer taking the time to get to know his customer.
As long as we let computers substitute for human judgment we can expect the borrower to try and game the system. I know we cannot go back to the old days, which were not that, good, but the current system is not working either. People with true integrity are being unduly punished and the scoundrel walker is getting a pass. Something must be done systematically if the residential credit markets are to forestall greater government intervention and meddling and tinkering with the system.
As long as this perverse situation tyrannizes the borrowing public, the lending institutions can expect great animosity and harm to their reputations. If it continues another few years, the lenders can expect the public to rise up politically and use the power of their vote to regulate the industry. It may even be like the S & L debacle of the 1980s—Oh, wait, there are no more S & L’s to hand out toasters. The borrowers are not in a position of power to finesse a solution to what seems to be an impossible situation. Only the lenders can act proactively and that will take not only integrity, but also morality and ethics. They will have to quit treating the borrower like a commodity.
Francis M. Miller is a management consultant who founded Lone Tree Consulting and specializes in strategy, workouts and turnarounds. He has degrees in math, finance and economics and a graduate degree in public policy from the University of Colorado Graduate School of Public Affairs. He spent a decade with firms such as Deloitte Touche and KPMG Peat Marwick. He was a U.S. Navy Seabee for six years during the Vietnam era and grew up in Montana. He was on the Douglas County Planning Commission and the Infrastructure 2050 Committee. He blogs at www.theThoughtCzar.com
To read Mary Winter’s column, “The Wisdom of Walking Away From Your Mortgage, please visit this link.< class="related_post_title">Related Posts:>