For Immediate Release
Chicago, IL – May 11, 2010 – Zacks.com Analyst Blog features: Blackstone (BLK), Bank of America (BAC), JPMorgan Chase (JPM), Fannie Mae (FNM) and Freddie Mac (FRE).
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Here are highlights from Monday’s Analyst Blog:
Mortgages Still Flooded
Theoretically, there should never be a foreclosure on a house that has negative equity. Regardless of how bad the homeowner’s cash flow situation is, they would come out better off by selling than they would by letting the bank take over the house. They can’t live there anymore, in either case, but if they sell they might still have enough cash to pay for the first month’s rent and the security deposit when they go to rent a new place. They get nothing if the bank takes it over. For those who are just a little bit underwater, they still have reasons to keep paying their mortgages, but as the depth increases, the reasons become increasingly non-economic.
Yes, the hit to your credit rating is an economic cost, but the main factors are a sense of shame in losing your house. Funny, the major players in the commercial real estate market are utterly shameless in this regard. Blackstone (BLK), for example, is one of the biggest money management firms in the world, and is highly profitable, but they had no trouble mailing in the keys on a $4.4 billion mortgage on the Stuyvesant Town apartment complex in New York. Donald Trump has defaulted on mortgages more times than I can remember, yet he gets to be the one saying, “You’re fired,” not people saying it to him.
At What Point Does Defaulting Become an Option?
Other non-economic factors are that people might really love the house they are in, the neighborhood, the kids’ schools, etc. Those things can be important, and might be a good reason to keep paying on your house if it is five or ten grand under water…but what if you are $100,000 grand under water?
Well $100,000 under water is not that much if the house is worth $1.5 million, and the mortgage is for $1.6 billion. On the other hand, $10,000 is a lot if we are talking a house that is worth $40,000 and a mortgage of $50,000. The person living in that $40,000 house probably makes a lot less than the person in the $1.5 million home, so that $10,000 could be 25% of their income for a year.
Really it is the percentage you are under water as much as the absolute amount that determines when it makes sense to simply walk away. Keep in mind that banks don’t really foreclose right away, and right now they have been much slower than they have been historically in foreclosing due to the huge backlog. Thus it is possible to live for months and months, often well over a year, rent and mortgage free before the sheriff shows up at the door.
Most economic theory is based on the idea of Homo Economus, the idea that all people will make economically rational decisions. Yet if you own a home, you can effectively sell if for whatever the value of the mortgage is, simply by not paying your mortgage. There are few other things that people regularly continue to pay for when they are worth far less than what people are paying.
However, if people really started to act in an economically rational way, they would probably sink the whole economic system. There is no way that Bank of America (BAC) or JPMorgan Chase (JPM) could really survive if everyone who was underwater on their mortgage defaulted.
Yes, they have raised a lot of capital, and by keeping their dividends low and not buying back stock, the steep yield curve is allowing them to replenish their capital quickly. But if people in mass woke up and started to act in an economically rational manner, that capital would be depleted quickly.
People walking away are also a big part of the reason that the losses at Fannie Mae (FNM) and Freddie Mac (FRE) are going to remain in the multibillion a quarter level for the foreseeable future. Since we as taxpayers own 80% of both of them, that is a problem for all of us.
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