bacon dreamz writes:
DV01st!
bacon dreamz | 01.29.08 - 11:51 am | #

bobn writes:
Whines: This post is too loooong.


First?
bobn | 01.29.08 - 11:51 am | #

AllenM writes:
Now that aptly and crisply sums up what I have been talking about.

The markets will no longer continue to function without pricing in a *huge* risk premia, and that risk premia will *force* house prices much lower (due to payment increase).

The real solution to this was to allow *wages* to start rising quickly.

However, that is a solution that the FED will fight to the death, so now we are in a corner equilibria with a constrained solution set.

Too many houses, too little income to cover higher interest rate mortgages necessary for *investors* to accept negative convexity.

One other topic that goes with this- lengthening duration throwing sand in the gears of perpetual refis and sales of gse covered MBS bonds.

Save that one for another day;-}

Someday this war's gonna end...
AllenM | 01.29.08 - 11:53 am | #

Bearish writes:
This is such a great post - I guess I'm not the only one who spent their former life geeking over OAS and convexity.

One question though - regarding the "default put" - don't most refis have recourse to the borrower?
Bearish | 01.29.08 - 11:53 am | #

Anonymous writes:
UberNerd on tape/CD?
Anonymous | 01.29.08 - 11:55 am | #

albrt writes:
Don't want anyone to miss the superbly ruthless website posted by REBear on the previous thread:

http://www.youwalkaway.com/

You Walk Away The Personalized Plan

I especially like the pictures of happy families packing up boxes as they prepare to walk away.
albrt | 01.29.08 - 11:56 am | #

Winston writes:
"The trouble is that convexity involves a whole bunch of seriously geeky math and computer models and normal people probably don’t want to go there. (I don’t even want to go there.) So as a compromise, this is a very quick and simple explanation of convexity."

Awww, but I like geeky math... But then again, my biggest frustration with my career with an engineer is that I don't get to do enough calculus. Anyhow, it seems that the other way that lenders can encourage repayment of their loans is to aggressively pursue legal judgments against people who default in states that allow them and to try really hard to get those who committed actual fraud prosecuted. In fact, it might make a good deal of sense to do this even in cases where there isn't a good chance of additional economic recovery to increase the risk and headache of choosing to default. Another thing that lenders might want to try is an MPAA like advertising campaign in which they remind people that they are responsible to pay their debts.
Winston | 01.29.08 - 11:59 am | #

Tanta writes:
One question though - regarding the "default put" - don't most refis have recourse to the borrower?

Another great example of why this shit's so hard to model.

Yes, refis are generally recourse. However, "recourse" really means that if the lender wants to go after you for a deficiency judgment, the lender must choose judicial FC. (Some states, of course, require only judicial FC, like OH. But in states like CA, there is a choice of non-judicial/power-of-sale FC or judicial FC.) So then it becomes a question of which ends up cheaper: winning your deficiency judgment (which you hope the borrower can pay) by spending more on court costs, or just writing it off and going the non-judicial route.

As it happens, loans that are already refis (that are originated as refinance loans) have different prepayment characteristics than purchase-money loans anyway. (All other things being equal, once it refied the more likely it is to refi again if it's in the money. The "efficiency" with which purchase-money borrowers will refi is more uncertain.)
Tanta | Homepage | 01.29.08 - 12:00 pm | #

Drew writes:
Congratulations on your thesis.

The Trustees of CR University, to whom these presents may come greeting be it known that Tanta, having completed the studies and satisfied the requirements for the degree of Doctor of Mortgage Puts & Calls?, has accordingly been admitted to that degree with all the rights privileges and immunities thereunto appertaining.
Drew | Homepage | 01.29.08 - 12:02 pm | #

sdtfs writes:
Gee, you say "sociopath" like it's a bad thing.
sdtfs | 01.29.08 - 12:02 pm | #

Tanta writes:
Anyhow, it seems that the other way that lenders can encourage repayment of their loans is to aggressively pursue legal judgments against people who default

In essence, I think the problem we're having at the moment is that lenders will never do this until ruthless puts get to be a big problem. They never act "proactively" because, you know, they have to report the expenses of doing that.
Tanta | Homepage | 01.29.08 - 12:03 pm | #

poszi writes:
Tanta,

Maybe the possibility of "exercise of the put option" is not in the contract but in a non-recourse state, it is implied by the law. I can't find such behavior ruthless.

In the good old days, there was guarantee that it is not worth to default, called downpayment. Just like VIX was incredibly low in 2006 "Goldilocks-economy", the lenders thought the price of this "put option" was minimal and mispriced it.
poszi | 01.29.08 - 12:05 pm | #

AllenM writes:
Tanta, one of the problems is that you are not throwing rocks at the insane mortgage models used by wall street to *value* the exotics and subprime.

How could anyone seriously buy stuff like that for 101% of face value? Was there no thought of any losses on the part of bond purchasers?

In other words, wall street distorted the entire mortgage market by hatching a bubble that once going, was perpetuated by tranche slicing.

In other words, they built the bubble, and now they complain that it blew up. Make wall street take their losses and now the government needs to step in and correct the market failure that is now becoming obvious.

Bah, this is taking too long to reach bottom, and there seems to be yet another false dawn while we talk about real crisis in the machinery.

Someday this war's gonna end...
AllenM | 01.29.08 - 12:08 pm | #

Jas Jain writes:
--
Options Theory doesn't help price fraud. Once you have a totally fraudulent activity, even though it is legally sanctioned, all pricing mechanisms are doomed to failure.

Made a killing of long-term puts on Fraudentials (sold 65% at average of 6X and still holding 35%),

Jas
Jas Jain | 01.29.08 - 12:09 pm | #

Tanta writes:
In the good old days, there was guarantee that it is not worth to default, called downpayment.

Exactly. The social purpose of non-recourse laws is not to give ruthless borrowers a put. It is to remind lenders that if they are stupid about LTVs and appraisals, they are giving ruthless borrowers a put.

Of course this behavior is "ruthless." For many people it's quite rational, but default is default. My whole point was that people are looking for reasons to escape the term "ruthless."
Tanta | Homepage | 01.29.08 - 12:11 pm | #

Marcus Aurelius writes:
I could be way off, but it seems to me the problem cannot be confined (contained?) to the relationship between the borrower and the lender. We are, and have been, to my understanding, talking about bankruptcy of the borrowing party. The lenders will seek judgment and/or criminal fraud actions against those who simply "walk-away". Once that happens, the income and assets of the defaulting party will be attached, and that ain't gonna' be pretty.

Am I missing something, here?
Marcus Aurelius | 01.29.08 - 12:12 pm | #

BG writes:
Tanta,

"The only situation in which “giving the house back to the bank” would literally be possible is if you bought the house from the bank (say, it was REO) and the contract explicitly gave you an option to sell it back to the bank, whenever you wanted to, at a price equal to your loan balance. Nobody writes REO sales contracts that way."

Hmmnn. It appears to me that there might be a role for an explicit (rather than the current implicit) put, here. Write the mortgage and embed a non-tradeable put.
BG | 01.29.08 - 12:14 pm | #

dryfly writes:
Convexity - ask and ye shall receive. With Tanta it comes both barrels at once... ;)

Thanks T - now I'll have to kill some trees to read this one.

dryfly | 01.29.08 - 12:16 pm | #

Winston writes:
Marcus,

I know several fraudsters who are confident that the banks won't pursue them even though they've defaulted (or are about to default) on their loans. I really think that there is a widespread perception that the worst thing that can happen to you in foreclosure is that you have to give up the property.
Winston | 01.29.08 - 12:17 pm | #

Tanta writes:
Hmmnn. It appears to me that there might be a role for an explicit (rather than the current implicit) put, here. Write the mortgage and embed a non-tradeable put.

That has been suggested.

Good luck building a model that lets you price it.

There was a time when some S&Ls basically did write puts on REO sales. Then they blew up and the regulators got pissy about the subject. If you sell REO that way, you carry the liability. I don't think many of these institutions could afford to sell their REO with a repurchase agreement.
Tanta | Homepage | 01.29.08 - 12:17 pm | #

Tanta writes:
We are, and have been, to my understanding, talking about bankruptcy of the borrowing party.

That's the "distress" default.

Actually, we are talking about non-bankrupt defaults.
Tanta | Homepage | 01.29.08 - 12:19 pm | #

trail writes:
Marcus - I think the real issue is that we're NOT talking bankruptcy, we're talking people who can easily afford to make their payments, stay up to date on their credit cards, probably even sock money away in their 401ks. They've just decided that there is a financial benefit to defaulting on their mortgage loans. And the love of their homes, their communities, their children's schools, is no longer enough to outweigh the financial benefit. It's a rootless society that just follows the money.
trail | 01.29.08 - 12:21 pm | #

ratefink writes:
If I lent money to a risky small business, some part of my payback calculation includes the probability of the business going BK, and this used to be done for individual borrowers as well. The idea that I will lend money at the same rate (or at all) always had to include not only what happens in good times, but in bad. It was "ruthless" competition on the part of the lending conduits which caused them to slash their rates below what their risk equations must have told them would be the consequences in bad times; or to hide those equations altogether. Too much lending capacity, just like to many factories producing buggy whips, and at some point it falls over.
ratefink | 01.29.08 - 12:23 pm | #

Tanta writes:
Tanta, one of the problems is that you are not throwing rocks at the insane mortgage models used by wall street to *value* the exotics and subprime.

You mean I'm not talking about the insanity of pricing credit risk. No, I am just trying for once to talk about something other than credit risk. There have always been and will always be optionality issues with non-exotic prime loans. In fact, the "ruthless" borrower is most likely to have prime credit.

To be honest, there wasn't always all that much wrong with those models. All you have to do is extract the assumption that RE always appreciates, and they work fine.
Tanta | Homepage | 01.29.08 - 12:24 pm | #

Rob Dawg writes:
Nihilist Anarchist Rationalizers. Too bad NAR is already taken.

Shouldn't terms and conditions to mortgage loans be adjusted to remove the convexity? Requiring a down payment and early prepayment penalties obviously skew towards this goal. I guess the only reason convexity and therefor in the money puts were allow to persist was because there was an upstream market that was willing to accept them. My sense is that the solution will come from that side of the business as well. New loan standards will be based upon what can be resold. That leads us to the impending horror of the GSEs preparing to be the repurchaser of last resort.

Thank you Tanta for this most illuminating OberUberNerd Monograph (not to be confused with a monoline).
Rob Dawg | Homepage | 01.29.08 - 12:25 pm | #

Jas Jain writes:
--
"I know several fraudsters who are confident that the banks won't pursue them even though they've defaulted (or are about to default) on their loans."

"fraudsters" know that if they defraud other Fraudsters they are relatively safe.

Kill poison with poison: Let one group of fraudsters kill the bigger group of Fraudsters!

Jas
Jas Jain | 01.29.08 - 12:25 pm | #

Aheadofthecurve writes:
Wow, Tanta. That is better written than 99% of what I read.

Is there a list somewhere of recourse vs non-recourse states?
Aheadofthecurve | 01.29.08 - 12:26 pm | #

ratefink writes:
They've just decided that there is a financial benefit to defaulting on their mortgage loans. And the love of their homes, their communities, their children's schools, is no longer enough to outweigh the financial benefit.

And where in the world would they get the idea that their purpose in the world depends primarily on the financial benefit that they generate to society?
ratefink | 01.29.08 - 12:27 pm | #

rcyran writes:
This is gonna take some serious slogging. But as Robert Venturi said, "less is a bore".
Thanks Tanta
rcyran | 01.29.08 - 12:27 pm | #

Monkey In Chief writes:
The only possible way to get back to an environment in which ruthless default is rare is to abandon the “innovations” that give rise to them: no-down financing, wish-fulfillment appraisals, underpriced investment property loans, etc.

What surprises me is that the industry is not smart enough to have already abandoned these "innovations" or at least starting pricing them appropriately. Why the industry is originating or why investors are still buying high LTV loans without a huge premium on the yield is beyond me.

It's not that hard to price the implied puts. Any reasonable assumption about home price volatility and underwater buyers defaulting will show a substantial premium for writing the embedded put.
Monkey In Chief | Homepage | 01.29.08 - 12:29 pm | #

Lawyerliz writes:
I repeat what I said on a previous thread. There are not enough judges and minions of same to begin thinking of collecting on more than the most minor percentage of hypothetical dificiency judgements. And the banks and lenders continue to cut their personell. If this was to be done, it would need lobbyists in the most hard hit states to start a foreclosure court, with extra high filing fees, said fees to pay for the extra judges, minions, sheriffs, and courtspace. Filing fee in Miami is, umm, a bit more than $250.00. Would the banks pay triple, say, just a guesstimate, to file to pursue a deficiency judgt along with the foreclosure, even to get fast attention? I doubt it.

Their business model is firing people and cutting costs. Pursuit of deficiency judgts might mean everybody else in civil court will have to wait longer. Maybe mean that in Miami, say, you might have to pull judges away from doing divorces and child custody, and probate and mental health work to do dificiency judgts. Frankly, it's not gonna happen. Keeping divorcing spouses from killing each other and keeping kids with the right parents is far more important. Not that the judges do a good job at that, anyway. They are too overworked, and the "system" is underfunded for kids by at least one half.
Lawyerliz | 01.29.08 - 12:29 pm | #

Tom in AZ writes:
Tanta

Even for someone as thick as me, this is great.
Tom in AZ | 01.29.08 - 12:29 pm | #

Tanta writes:
I guess the only reason convexity and therefor in the money puts were allow to persist was because there was an upstream market that was willing to accept them.

Not necessarily.

One way of looking at is is that the social goal of increasing homeownership was achieved at the cost of convexity problems. Of course you can ask everyone to make a 20% down payment and accept a prepayment penalty. You therefore rapidly decrease the pool of home buyers and sacrifice workforce mobility. You can also make everyone take ARMs whether they want to or not. While there are some convexity issues with ARMs, it's nothing like the curve you see with FRMs. Our expectations are that people can have not just cheap mortgage financing, but fixed rate inflation protection.

Somebody decided we could have it both ways: an "ownership society" and cheap mortgage rates.
Tanta | Homepage | 01.29.08 - 12:30 pm | #

Anonymous writes:
Lenders never thought prices would fall this fast when the $ tap was shut off....now the model is broken since refis don't work so good.

As you inferred, people who are made to feel 'ruthless' thru correspondence from the lender when turning in the keys should just repond with the old childlike one-liner: 'Takes one to know one' :)
Anonymous | 01.29.08 - 12:30 pm | #

trail writes:
I think they feel their purpose is more along the lines of the financial benefit they generate to themselves.

And where do they get that? Angelo, maybe...
trail | 01.29.08 - 12:31 pm | #

bobn writes:
Re: http://www.youwalkaway.com/

"
7. How much is your service?

A. With our money back guarantee, you get it all for only $995.00.
"

Is this for real, or is it brilliant satire?
bobn | 01.29.08 - 12:32 pm | #

Aheadofthecurve writes:
Tanta- Canada has reasonable rates of homeownership (somewhat less than the US, but still very respectable) with no fixed-rate mortgages, no zero-down and mortgage interest is NOT tax-deductible.
Aheadofthecurve | 01.29.08 - 12:33 pm | #

Vikram writes:
Speaking of "puts", I came across this website

You Walk Away

A company to help you make this put decision :-)
Vikram | 01.29.08 - 12:34 pm | #

seminole writes:
In florida at least it is really tough to collect on a judgment against an individual.
seminole | 01.29.08 - 12:34 pm | #

Aheadofthecurve writes:
Re: Canada

Actually latest data I could find was from 2005. US was 69 %, Canada 67%. All without fixed-rate or 0 % down and interest is not deductible.

So, none of those things are essential for homeownership
Aheadofthecurve | 01.29.08 - 12:37 pm | #

WSF writes:
The lenders going after them for fraud may be exaggerated. Fraud cuts both ways if the lenders were somehow being fraudulent. I'll bet these attorneys drumming up the walk away business are looking for patterns. If lenders initiate actions and facts come out against them, the class action bar will be sitting there salivating. Hell, I wouldn't be surprised to see them goad lenders into the public arena of the courts to gather free "intelligence".
WSF | 01.29.08 - 12:38 pm | #

Emma Anne writes:
(On You Walk Away)

"I especially like the pictures of happy families packing up boxes as they prepare to walk away."

Yeah, that's bizarre. Shouldn't they look grave? Wistful at least?
Emma Anne | 01.29.08 - 12:38 pm | #

cat writes:
7. How much is your service?

A. With our money back guarantee, you get it all for only $995.00.

Do you take credit? I promise I'll pay you back.
cat | 01.29.08 - 12:40 pm | #

Rob Dawg writes:
increasing homeownership was achieved at the cost of convexity problems.

Okay, that makes sense.

Of course you can ask everyone to make a 20% down payment and accept a prepayment penalty. You therefore rapidly decrease the pool of home buyers and sacrifice workforce mobility. You can also make everyone take ARMs whether they want to or not.

That would be Australia. Unfortunately they seem to be having many the same troubles as we have.

I am surely happy to have my 4.99% 30yr and Prop 13. While rates are dropping, excuse me, being forced lower now eventually inflation will be unable to be ignored. If the current crop of FB refi to low fixed and then this happens they might be okay but at the expense of banks being even worse off.
Rob Dawg | Homepage | 01.29.08 - 12:41 pm | #

Marcus Aurelius writes:
Not trying to be hard-headed (we are what we are), but what's to stop this scenario:

1. Lender sues for performance on the mortgage of the abandoned asset.

2. Borrower either doesn't show up, or shows up and doesn't have a case.

3. Court finds in favor of lender and issues judgement against borrower - attaching assets and dunning future income.

4. Borrower either satisfies judgment or files bankruptcy (if the lender is smart, and if the borrower doesn't show up in court, the court can make it's award non-dischargeable in BK Court).

Either this scenario will play out as described, or theft by fraud has found a legal loophole.
Marcus Aurelius | 01.29.08 - 12:41 pm | #

Dwight Cramer writes:
Presumably the currently typical decision not to pursue borrowers in recourse situations for the deficiency is rational, and based on an assessment of the legal and administrative expense of doing so, as opposed to the anticipated recoveries. In other words, why try to get blood from a turnip?
Two probable circumstances are going to compel a reassessment. First, if the problem becomes common, those legal and administrative expenses can be reduced significantly on a per file basis as they are spread over a much larger caseload. Second, more and more of the turnips are going to be worth squeezing. The whole endeavor will start to resemble something like collecting past due child support.
Finally, if the 'ruthless' problem becomes widespread, a certain amount of exemplary justice, per encourager les autres, may prove effective.

These observations are offered without any attempt to address the political fallout from more aggressive recovery efforts.
Dwight Cramer | 01.29.08 - 12:44 pm | #

Shnaps writes:
Tanta - Looks great I wish I had time to read it all.

Two suggestions:
A) add PODCASTS to accompany posts of this length/topics of this depth.

B) hire James Earl Jones to do voice for A above.
Shnaps | Homepage | 01.29.08 - 12:46 pm | #

Marcus Aurelius writes:
James Earl Jones is already the voice for the pig.
Marcus Aurelius | 01.29.08 - 12:47 pm | #

Mike in Long Island writes:
who coodanode that mortgage pig had fat tails instead of cute curly ones....
Mike in Long Island | 01.29.08 - 12:49 pm | #

daveNYC writes:
Shouldn't terms and conditions to mortgage loans be adjusted to remove the convexity? Requiring a down payment and early prepayment penalties obviously skew towards this goal.

You can't remove the convexity. As long as the law requires that pre-payments be legal, you're still going to have that positive slope at the left end of the graph.
daveNYC | 01.29.08 - 12:49 pm | #

arrrgh writes:
Writing from California which still has the 'one form of action' rule*

One thing I noticed a lot -- people would get a mortgage then talk about being just deluged with phone calls, several a day, from the very same mortgage lender -- offering better deals starting _immediately_. It didn't make sense until I remembered.

One form of action -- the rule only applies to _first_ morgtages.

If you want to block someone from having that legal protection, get them to refinance.

Clever lenders? The big fast mortgage shops must have known they could remove that protection and get access to both the house _and_ the other assets on default, if they could get people to refinance.

And if they knew they were making loans with a high likelihood of eventual default, and the business model was to get at both the houses and the other assets, this would be a tactic.

Til I thought of that, it struck me funny how the mortgage that was "the best available terms" one week was always possible to improve on, and at such low cost, the next week. And why were they so actively phoning their first mortgage customers trying to give away money like that?

Anyone who lives out here knows, the phone would ring several times a day -- any phone, anywhere -- with mortgage calls.

Or maybe I'm too suspicious?

Nah.

_______
* In a first mortgage default, the lender has to choose _either_ to take the house, _or_ to go after the borrower's other assets.
arrrgh | 01.29.08 - 12:50 pm | #

iceman writes:
The administration is currently pushing for increasing the FHA loan amounts and the FHA maximum LTV up to 100%. This is not likely to remove the incentive to take another reckless loan on a still-too-high-priced house. If we aren’t going to ration credit with tighter guidelines and loan limits, then it will have to be rationed with pricing: eventually the models will “solve” the problem by increasing the costs of mortgage credit. You cannot simply keep writing “free puts.”

This is so well written.

And, then you goto somewhere like quickenloans.com and see all the current ways they try to provide no/low downpayment financing.

A LOT of people still don't get what makes a healthy real estate market.
iceman | 01.29.08 - 12:50 pm | #

fuguez writes:
I believe that there is a real option.
I am not saying it is legal.

It is an exchange option: put on the House and a call on the future payments (rather than the "House price").
fuguez | 01.29.08 - 12:53 pm | #

Anonymous writes:
aotc- please take the time post a graph or table w/ price-to-income ratios for various Canadian cities.
Anonymous | 01.29.08 - 12:55 pm | #

TMoney writes:
On Ruthless Default...

Ultimately, there is no way anyone can mobilize “social acceptability” as a defense against the ruthless put (even if you wanted to). The industry has, in fact, created the conditions in which it’s rational, and as long as it’s rational it will go on.

Bravo, Encore, Encore. The bankers must reap what they've sown. No Tanta (or her ilk) in the underwriting department means these sorts of problems are going to crop up. Moreover, even if they bring Dr. Tanta back now (at a much high salary than before) its too late to stem the bleeding.
TMoney | 01.29.08 - 12:55 pm | #

BG writes:
Tanta,

"Like most sociopaths, they don’t understand why “ruthless” would be considered insulting or what this term “social acceptability” might mean."

Ow! That hurt. Well, ok, maybe not really. Though I think your comment might be more applicable to basic human nature than you think. Attached is a nice workup that basically amounts to answering the question "Why didn't the average Soviet citizen exercise a 'Stalin Put' in 1942?"

http://www2.warwick.ac.uk/fac/so...rs/ totalwar.pdf

People can be darned cold-blooded. In any case, your answer on the embeded put idea is interesting. At first blush, I'd figure modeling an explicit put would be easier than working with the current "Will they, won't they?" environment. If a lender is selling you such a put, they are sending you a signal about their thoughts on the direction of housing. Under the current circumstances, some transparency might be a selling point. I smell opportunity! :^)
BG | 01.29.08 - 12:57 pm | #

wally writes:
"My whole point was that people are looking for reasons to escape the term "ruthless.""

The word does not occur in the contracts, only in your trade jargon. The traditional defense against the default is, as you nicely point out, is in the original structure. You have a premium for the risk or you require skin in the game. (In either case, you do not need to resort to name-calling to be protected). In some circles, skin in the game is reinforced by a kneecap or two in the game. It has always worked.
wally | 01.29.08 - 1:00 pm | #

burnside writes:
Tanta,

Thank you for crispness, clarity and at long last convexity.

Someone's comment earlier today invoked a reversal of the usual moral hazard argument (viz, if you keep paying irrational LOs you just get more of 'em) as a defense of jingle mail. I'd say that Spencerian moment, if there's to be one, comes only at the closing.
burnside | 01.29.08 - 1:00 pm | #

Anonymous writes:
Tanta, you are in your element today! Great post - this really clarified things for me.
Anonymous | 01.29.08 - 1:01 pm | #

s9 writes:
Lemme see if I get this straight... when an individual does it, it's called "ruthless default," but when a corporation does it, it's called "meeting fiduciary responsibility to shareholders."

Imagine my surprise to discover that financial corporations might be concerned about the social acceptability of individuals doing what the same corporations are regularly lauded by the financial press for doing themselves, i.e. letting bad contracts go to liquidated damages when that turns out to make more financial sense.
s9 | Homepage | 01.29.08 - 1:01 pm | #

seminole writes:
Marcus, issuing the judgment and dunning income are two seperate things ... court has no problem issuing the judgment but dunning the income without the debtor being present? Might be the same as making a family homeless ... judges have to run for re-election here ... nobody is going to risk taking the food off the family's table.
seminole | 01.29.08 - 1:02 pm | #

jcsc writes:
Tanta,
Thank you for the amazing post.

What would you consider the possibility that mortgage lending will be further socialized through the GSEs? In my ignorance, I perceive another possibility: somewhat tighter guidelines, somewhat rational loan limits, with the risk downside guaranteed by the gov't to avoid risk re-pricing.
jcsc | 01.29.08 - 1:04 pm | #

Tanta writes:
Not trying to be hard-headed (we are what we are), but what's to stop this scenario:

Nothing stops that scenario.

But these mortgage pools were not priced originally assuming that's how they'd get principal back.

Try it this way: what discount rate would you use there? How long will it take you to get your money?
Tanta | Homepage | 01.29.08 - 1:04 pm | #

Aheadofthecurve writes:
aotc- please take the time post a graph or table w/ price-to-income ratios for various Canadian cities.


Here is a link to a recent study from RBC.

http://www.rbc.com/economics/mar...t/pdf/ house.pdf
Aheadofthecurve | 01.29.08 - 1:06 pm | #

burnside writes:
i think we're suffering a walkaway bot invasion :0)
burnside | 01.29.08 - 1:09 pm | #

Allen C writes:
"You cannot simply keep writing “free puts.”"

There is/was implied premium in a high FICO score. At some point in the future you can create a simple graph of defaults with FICO scores and negative equity as variables. You can imagine the shape of the curve.
Allen C | 01.29.08 - 1:10 pm | #

Marcus Aurelius writes:
seminole | 01.29.08 - 1:02 pm | #

it's my understanding that in civil actions, if the borrower (Defendant) doesn't show up in court, the lender (Plaintiff) will be granted summary judgement (within the law and the jurisdiction of the court to grant such relief). If there is no objection from the opposing party, and the request is within the law, the moving party will get what it asks.

I could be wrong.
Marcus Aurelius | 01.29.08 - 1:11 pm | #

jmay writes:
Holy crap, Tanta.

Someone should give you a book deal already.
jmay | 01.29.08 - 1:12 pm | #

Tanta writes:
In either case, you do not need to resort to name-calling to be protected

Look, this isn't about name-calling.

You could, I suppose, write a contract that never ever carries any risk to one party. (I don't know why you would, but you could.) In that case, there would never be "default."

Whenever there is any risk to a party in a contract, there is the possibility that the party will try to get out from under that risk by refusing to abide by the terms of the contract. That is called "default."

"Ruthless" is simply the term we use for borrowers who will always seek to maximize their gain, regardless of the rights the contract gives them.

Similarly, "entitled" is the term we use for people who expect to enter into contracts in which they can never lose.

What's funny about all of this is, again, the resistance to the term "ruthless." My view is that people wish to overcome their inhibitions about ruthless economic behavior without having to admit it. They therefore take umbrage over the term.

Did you watch the 60-minutes video? What other non-judgmental term would you use to describe the borrowers interviewed?
Tanta | Homepage | 01.29.08 - 1:13 pm | #

Russ writes:
Tanta,

Thank you for the education. Great job!
Russ | 01.29.08 - 1:19 pm | #

wally writes:
""Ruthless" is simply the term we use for borrowers who will always seek to maximize their gain, regardless of the rights the contract gives them."

You mean as opposed to people who seek to minimize their gain? As I said, it is your trade jargon. I don't mean by that to say I approve or not - I would probably never default no matter how far underwater, but... I'd say 'opportunist' or 'defaulter'.
wally | 01.29.08 - 1:21 pm | #

BG writes:
s9,

"when an individual does it, it's called "ruthless default," but when a corporation does it, it's called 'meeting fiduciary responsibility to shareholders.'"

No, it's ruthless in both cases. You can use precisely the same sort of analysis to determine when a company is likely to default on its bond obligations, with the only added complexity being the need to take into account asset volatility.

http://atlas-conferences.com/c/a.../c/a/j/g/ 65.htm

(Techincally, I think you need to do the same for the underlying in the housing/mortgage case, but volatility is a lot lower.) (Ha!)
BG | 01.29.08 - 1:23 pm | #

El Goyo writes:
Nothing stops that scenario.

Disagree. In the current environment lenders and servicers are being vilified for the housing "crisis" for just following SOP - foreclosing when the payments stop coming in.

If they were to begin aggressively pursuing deficiency judgments where allowable it would be a public relations nightmare - and would undoubtedly incite legislation to extinguish it as an option.
El Goyo | 01.29.08 - 1:26 pm | #

Rob Dawg writes:
"when an individual does it, it's called "ruthless default," but when a corporation does it, it's called 'meeting fiduciary responsibility to shareholders.'"

And when a government does it, it's called 'fixing Social Security.'
Rob Dawg | Homepage | 01.29.08 - 1:30 pm | #

Marcus Aurelius writes:
This is getting Shakespearean. Everyone's a fool, they all serve their own interests, there's much treachery and behind-the-scenes plotting, and everyone dies in the end.

Neither a borrower, nor a lender be...

Alas, poor Real Estate Industry, I knew him...
Marcus Aurelius | 01.29.08 - 1:30 pm | #

Anonymous writes:
aotc- Thanks for the data.

Other than the 'coastal' cities, most areas seem not to have recovered from the 2000 house bubble yet, unlike the US. Plus, the down-payment required in the study is 25% !! Gee, if that type of study was done for the US, no one could 'afford' a home. If that is even remotely close to the average down payment in Canada, then jingle mail generally won't be happening like in the US, as Tanta explained.

You seem to live in one of the bubble markets..worried (yet)?
Anonymous | 01.29.08 - 1:33 pm | #

jim a writes:
Well, I suspect that the prices/rates for recourse and non recourse loans are very similar. This would indicate that the "ruthless put" has not been priced in. Only the ruthless, not the insolvent are worth getting a deficiency judgement against.

And I'm probably not the only person to dislike the term "negatively convex." Shouldn't the term be "concave"?
jim a | 01.29.08 - 1:35 pm | #

MLM writes:
Thanks Tanta.

In thinking about contracts I have negotiated, it occurs to me that one would be naive not to negotiate with the understanding that the other party is likely to behave in a ruthless manner if it becomes of significant advantage to them.

Seems to me this all gets back to the idea that if real estate only goes up, then the ruthless/jingle mail case isn't worth worrying about. Oops.
MLM | Homepage | 01.29.08 - 1:37 pm | #

Allen C writes:
ruthless - having no pity; cruel

Sorry...if you have a secured loan and the underlying asset drops in value, value is gone. There are two interested parties, the mortgagor and the mortgagee. Why should the borrower assume the lender's loss because the lender was too foolish to demand adequate security or premium?

If I had a mortgage and an earthquake leveled my house, I'd walk. It's not a matter of ruthless, it's simply the deal. It's not an unsecured or personal loan. Bondholders are simply equity investors with a senior claim and receive interest in lieu of excess return and/or capital appreciation. When was the last time you saw an equity investor kick in money to make the bondholder whole? Why should it be any different for the homeowner?

To me, ruthless is the bank sorting clearing checks from high to low in order to maximize NFS fees.
Allen C | 01.29.08 - 1:40 pm | #

Aheadofthecurve writes:
Anonymous-I'm Canadian, but live in the US, in a fairly non-bubble market. The really bubbly markets in Western Canada are dependent on oil (Alberta) and potash (Saskatchewan). What they do will depend largely on commodity prices. Vancouver is the haven for Hong Kong money. Prices have been sky-high there for a very long time. Canadians have a much higher savings rate than Americans and generally expect to save to buy a house. The government also runs a surplus.
Aheadofthecurve | 01.29.08 - 1:40 pm | #

dfb writes:
This is great commentary. Thanks for your insights.
dfb | 01.29.08 - 1:42 pm | #

Aheadofthecurve writes:
Tanta- Can't this be addressed through the tax code? If you walk away, the difference between what you owe and what the bank gets in liquidation is income to you. If you are distressed (job loss, illness, etc.) this can be waived. It could also be waived if you negotiate a modification in good faith. Then the IRS can collect. They are harder to escape than banks.
Aheadofthecurve | 01.29.08 - 1:44 pm | #

Hutch writes:
My father was forced into bankruptcy by his main creditor after two employees embezzled a large sum and vanished. Most of his debt was discharged. Three decades later and after uncounted arguments with new employees at various S&L's and banks he finished paying off the debt he had been forgiven, with interest. He wouldn't have bought this 'put' business or 'Force Majeure' either.
Hutch | 01.29.08 - 1:46 pm | #

Markel writes:
Wow.

Tanta, a question from the dummy gallery.

So, are we to understand that Washington thought higher GSE/FHA limits would juice the mortgage market by spreading the credit guarantee blanket wider, but instead it's simply spoiling the whole bunch with bad apples? Doesn't the credit guarantee make up for ruthlessness? I wish you'd do a nerd post further analyzing the conforming limit increase alone.

Oh, and to prove I'm not a complete dummy:

1. You can't really write a contract with absolutely no risk to one party. The law would not enforce it. It would be a gratuitous promise without consideration. Even if it's executory on one side only--say, you get prepaid for something--you can still lose if you don't perform, or if you find out the value of your performance suddenly tripled since you signed the contract. A contract is both a bargain and a bet, by nature.

2. One of the characteristics of "ruthless" behavior is that it's much more likely to be socially destructive. When you analyze a contracts case, for instance, you're supposed to ask who future litigants in similar actions would root for. Often, future defendants will be rooting against the defendant in the case at hand--because if they prevail, these future folk will no longer be able to enter into these types of contracts at all.
Markel | 01.29.08 - 1:46 pm | #

ShortCourage writes:
Tanta,

Thank you for the carefully, well-written, appropriately long post.
ShortCourage | 01.29.08 - 1:48 pm | #

dryfly writes:
Try it this way: what discount rate would you use there? How long will it take you to get your money?
Tanta | Homepage | 01.29.08 - 1:04 pm | #

The best way for people to get their head around the difficulty in pricing is by imagining a "Chinese Auction" (sorry if somebody is offended - its what I've always heard them called)...

Imagine two parties each own half of an asset and they want to have a mechanism to buy the other out. They flip a coin and Party A wins. Party A then gets to set the price for the transaction but Party B gets to decide if s/he buys or sells at that price and Party A has to accept Party B's decision. Party A has to price very carefully.

Now imagine that were going on in the mortgage world when you are in front of the lender. Imagine you had to offer loan pricing & terms to the lender and the lender decides to either borrow to you or borrow FROM you at those terms.

Now knowing what we know about early early pre-pay and ruthless borrower risk... how would YOU price the offer knowing somebody else gets to decide which way the deal goes?

I have no idea how I'd price something like that. I wouldn't want to play that game - I'd put my money in a tomato can in the back yard instead unless I could get a lot higher price than is currently the norm. But I'd probably not want to borrow at the price I'd want to lend at either.

That's what the credit market is saying right now regarding the proposals to add big chunks of jumbo to their previous creamy smooth GSE conforming soup. No thanks - I'll eat at home.

dryfly | 01.29.08 - 1:48 pm | #

Tanta writes:
Why should the borrower assume the lender's loss because the lender was too foolish to demand adequate security or premium?

I'm not sure what, exactly, you think we're disagreeing about.

My own view is that very many, but not all, people will default if you put them in a situation in which the consequences of default are more to their advantage than not. That's why I have always been into down payments and good appraisals and all that other old-fashioned stuff. You don't enter into contracts with terms that are unfavorable to you.

There are, however, some people who understand a promissory note to be a promise that has to be kept, even if it becomes unprofitable. If you're willing to call these people "rubes" or "patsies" or "suckers," then I think you should be willing to call defaulters "ruthless."

This subject always reminds me of a hundred years ago when I was a salesclerk in a fairly upscale department store. Dealing with the return policy headache. If you take back too many ball gowns that were worn once (and cannot be resold at the price you just refunded), you'll have to do something about your prices to everyone. That's just the way it works. Otherwise you enforce more restrictive return policies that piss off people whose returns are legitimate.

I can't believe I grew up, left retail, and got into mortgages. Must be bad karma.
Tanta | Homepage | 01.29.08 - 1:53 pm | #

HARM writes:
S9

Lemme see if I get this straight... when an individual does it, it's called "ruthless default," but when a corporation does it, it's called "meeting fiduciary responsibility to shareholders."

Then...

Allen C

ruthless - having no pity; cruel

Sorry...if you have a secured loan and the underlying asset drops in value, value is gone. There are two interested parties, the mortgagor and the mortgagee. Why should the borrower assume the lender's loss because the lender was too foolish to demand adequate security or premium?

That about sums it up for me.
HARM | Homepage | 01.29.08 - 1:54 pm | #

Tanta writes:
Can't this be addressed through the tax code? If you walk away, the difference between what you owe and what the bank gets in liquidation is income to you.

Well, yeah, but we just changed the tax code precisely in the opposite way.
Tanta | Homepage | 01.29.08 - 1:54 pm | #

Zigurrat writes:
Liz...

I agree that there isn't the capacity or will to do a lot of criminal prosecution.

However, you could have some 'poster child' examples. Especially if they went after someone that fit the 'ruthless' criteria precisely. That is, someone that is sending the keys back on an expensive property and has enough income and assets that make them nowhere near hardship.

I don't know if it will be done, but it would be smart for the lenders to find some poster child examples the sooner the better.
Zigurrat | 01.29.08 - 1:55 pm | #

HARM writes:
I can't take credit for this, but it perfectly illustrates the hypocrisy of banksters accusing FBs who walk away of "unethical" behavior:

First to walk were the federal “regulators”.
Then the mortgage broker walked (after taking his commission).
Then the lender walked (after selling the loan).
Then the mortgage securitizer walked (after selling to pension/hedge fund).
Then the ratings agencies walked.
Last to walk was the borrower.
HARM | Homepage | 01.29.08 - 1:55 pm | #

BG writes:
AllenC,

"If I had a mortgage and an earthquake leveled my house, I'd walk. It's not a matter of ruthless, it's simply the deal."

I don't think that's quite it. Keep in mind that you are not buying the house from the lender, nor is the lender buying the house and then letting you use it for a fee. _You_ buy the house with money the lender gives you; the lender merely states as a condition that he gets dibs on the proceeds if you find yourself forced to sell. Your obligation was not conditioned on whether the house burns down, falls due to earthquake or termites or stands for a thousand years.

That said, I see nothing perjorative about saying that you'd ruthlessly protect and maximize your own value under the circumstances. Your counter-party (in fact, all potential parties) would do the same. That's the nature of an arm's-length transaction.

More practically, though, you do suffer the temporary cost of more limited access to further credit and/or greater difficulty in getting a job that works with large quantities of money. But this too shall pass....
BG | 01.29.08 - 1:56 pm | #

4shzl writes:
Did you watch the 60-minutes video? What other non-judgmental term would you use to describe the borrowers interviewed?
Tanta

A. rational

and

B. normative
4shzl | 01.29.08 - 1:59 pm | #

Aheadofthecurve writes:
"Well, yeah, but we just changed the tax code precisely in the opposite way."

I know and that's ridculous. After all, gains on option trading are taxable.

To compensate we could make a real loss (i.e. lose your downpayment in a short sale) deductable.
Aheadofthecurve | 01.29.08 - 1:59 pm | #

Tanta writes:
So, are we to understand that Washington thought higher GSE/FHA limits would juice the mortgage market by spreading the credit guarantee blanket wider

You give them too much credit, in my view.

As far as I can see, they're just trying to reflate house prices. That makes the ruthless borrower go away because default is no longer the best option.

In any event, these proposals are not dispersing risk, they're concentrating it. The private investors and portfolio lenders folded, and now we want the GSEs and FHA to be lender of last resort.
Tanta | Homepage | 01.29.08 - 2:01 pm | #

Rob Dawg writes:
... Party A then gets to set the price for the transaction but Party B gets to decide if s/he buys or sells at that price and Party A has to accept Party B's decision. Party A has to price very carefully.
My parents would let one kid cut the candy bar and let the other choose. The presumption is however that both sides want the same thing.
Rob Dawg | Homepage | 01.29.08 - 2:01 pm | #

lessismore writes:
Marvelous post; exceptional writing. What you call "ruthless," the law-and-economics law schools (Yale, Chicago, Virginia) call an "efficient breach." If it's any comfort, plenty of my classmates balked at such efficiencies when confronted with a now-unfavorable contract. I'm certainly curious to see just how many people are ruthless, er, efficient, in real life.
lessismore | 01.29.08 - 2:01 pm | #

HARM writes:
That said, I see nothing perjorative about saying that you'd ruthlessly protect and maximize your own value under the circumstances. Your counter-party (in fact, all potential parties) would do the same. That's the nature of an arm's-length transaction.

Xactly. In a rapidly rising market, would the lenders hesitate one second to foeclose on a down-on-his-luck borrower that was behind on his payments, just because that would be the "ethical" thing to do? A: Hell no.

Ruthless = rationally protecting one's own in a ruthless (and rigged) game.
HARM | Homepage | 01.29.08 - 2:02 pm | #

dryfly writes:

Covering this via the tax code is the wrong approach - that just brings in another (disinterested) third party. Its a pricing & terms issue. The market needs to price in the options risk better or offer term conditions that protect lenders from this risk (i.e. demand more down payment). In effect telling the borrowers to send us the keys if you want... we got a 20% head start on any loan losses.

Its silly to do anything else.

dryfly | 01.29.08 - 2:05 pm | #

Allen C writes:
Here is the disagreement...

"some people who understand a promissory note to be a promise that has to be kept"

If it's a personal loan or unsecured then yes I concur.

If it's a secured, non-recourse note with a formal lien on the underlying asset, then no.

The dress buyer in your story committed low level fraud. The homeowner (equity holder) is walking away because the value is gone leaving the lender (bondholder) with the remainder. If it's secured, non-recourse, it's the deal.
Allen C | 01.29.08 - 2:05 pm | #

MR writes:
Excellent post. I think too many people are whacked out about the term "ruthless".

Why don't we take a page out of Nixon's book (ala not useing the word "recession") and call it something like, "banana".

Alternatively, maybe we could rename the evil loans, "Voldemortgages".
MR | 01.29.08 - 2:06 pm | #

HARM writes:
When the banksters and so-called "regulators" start modeling "ethical" behavior as a matter of course, I'll change my tune. Until then... it's just chickens coming home to roost.
HARM | Homepage | 01.29.08 - 2:06 pm | #

Tanta writes:
If it's secured, non-recourse, it's the deal.

No, it isn't the deal. We would not call it "default" if it were the deal.

You do not have the contractual right to substitute the current value of your home for the current balance of your mortgage.
Tanta | Homepage | 01.29.08 - 2:07 pm | #

Price Stout writes:
Just wanted to say thx for any outstanding post. I've sent the link around to many folks already. Keep up the great stuff!
Price Stout | 01.29.08 - 2:08 pm | #

BG writes:
lessismore,

"I'm certainly curious to see just how many people are ruthless, er, efficient, in real life."

Merton rulz!
BG | 01.29.08 - 2:09 pm | #

HARM writes:
@Tanta,

Technically, the loans in a GSE portfolio are not "federally backed", and the GSEs are not "too big to fail". However, the bond market prices them and acts as though they were.

IANAL, but on a practical level, this (substituting the current value of your home for the current balance of your mortgage) seems to be the deal.
HARM | Homepage | 01.29.08 - 2:11 pm | #

ratefink writes:
I think that "ruthless" has a connotation of violence that implies that the borrowers are kind of aggressive predators, and that is what pulls peoples' (mine included) chains. These situations have been fostered by a deliberate and fundamental aggressive activity by investor groups and lenders to foster the housing bubble, slash risk management, and commodify living arrangements under terms that were of short term profit to their owners and there is no way that you can say that on a social level that the individual "poster children" had equal power in the relationship. The fact is, people in earlier generations not only had moral imperatives holding their feet to the fire to honor their obligations, they were more often than not more deeply embedded into a lively community of support, the very communities which have been dissolved by the aggressive actions of the lenders and financial "free" markets.
The behaviour of the 60 minutes couple can be neutrally described as "selfish", certainly, but there is only one side of this story which was so tightly organized to be "ruthless", I'd say.
ratefink | 01.29.08 - 2:11 pm | #

Tanta writes:
Anyone who thinks jingle mail is "part of the deal" with a mortgage will find out otherwise as soon as he tries to get another one.

He will then discover that the lender will charge him a much higher interest rate than he used to pay. He will ask why that is, and the lender will say it's because his credit report shows that he is a defaulter.

As someone else has already noted, the trouble in the boom was that we thought FICO offset down payment. FICO, of course, is supposed to measure your willingness not to default on debts.
Tanta | Homepage | 01.29.08 - 2:12 pm | #

ratefink writes:
FICO, of course, is supposed to measure your willingness not to default on debts.

Well, then you do get a free put.
ratefink | 01.29.08 - 2:15 pm | #

Price Stout writes:
If it's secured, non-recourse, it's the deal.

If you mean as a matter of law (or fact), you are simply incorrect.

There's the promissory note, in which the borrower (debtor) promises to repay the loan with interest. Then there's a separate mortgage (or deed of trust) executed by the borrower/debtor, which grants the lender an interest in the real estate and also contains a promise to repay the loan in accordance with the terms of the promissory note.

The mortgage is a security for the Note, it is not a substitute for the Note, which is exactly why it reaffirms the terms of the Note.
Price Stout | 01.29.08 - 2:15 pm | #

HARM writes:
Tanta,

If that is true, then potentially millions of former FBs will become renters for life. And that will mean far more inventory to choose from at lower prices for people -- like me-- who refused to participate in this massive Ponzi scheme.

How is that a bad thing?
HARM | Homepage | 01.29.08 - 2:16 pm | #

Tanta writes:
In a rapidly rising market, would the lenders hesitate one second to foeclose on a down-on-his-luck borrower that was behind on his payments, just because that would be the "ethical" thing to do? A: Hell no.

But it's quite rare to foreclose on the distressed borrower in a rapidly rising market. The distressed borrower can sell.

Either way, the lender just gets paid back. The sale proceeds over and above the amount of the debt belong to the borrower.

If we wrote shared-appreciation loans, now, that'd be different.
Tanta | Homepage | 01.29.08 - 2:17 pm | #

HARM writes:
Don't the GSEs & FHA make loans to people with foreclosures, once they've passed the 2-year mark? That's hardly "forever".
HARM | Homepage | 01.29.08 - 2:17 pm | #

Mstar writes:
Tanta writes:
Anyone who thinks jingle mail is "part of the deal" with a mortgage will find out otherwise as soon as he tries to get another one.

On a purely contractural basis, I have no problem with jingle mail. After all, business is business. What should prevent it happening is some adverse outcome - like destroying your credit risk.
Mstar | 01.29.08 - 2:18 pm | #

Tanta writes:
Don't the GSEs & FHA make loans to people with foreclosures, once they've passed the 2-year mark?

Only with documented extenuating circumstances. In other words, only if it's "distress" instead of "put."
Tanta | Homepage | 01.29.08 - 2:19 pm | #

Allen C writes:
"No, it isn't the deal. We would not call it "default" if it were the deal."

I most respectfully disagree.

If a corporation defaults on a secured, non-recourse loan, the lender exercises their senior claim on the asset(s). If the deal is secured, non-recourse, the lender has no right of further claim. That's the deal. No?
Allen C | 01.29.08 - 2:22 pm | #

Metrics Wonk writes:
Once again I wish you'd taught Economics at my college Tanta. Great post.
Metrics Wonk | 01.29.08 - 2:23 pm | #

mock turtle writes:
Tanta,

not too long....just right, and clear.

you are a fine teacher...maybe your next gig should be at a college...you students would appreciate your pointed explanations.

as for posters above who are exorcised about the term "Ruthless" in the mortgage industry...hey get over it...just a term

like is a "covered call" is wearing clothes and a "naked put" is when you are undressed and... just...(ok i wont go there)
mock turtle | 01.29.08 - 2:23 pm | #

Jack D writes:
Read the column on government sanctioned re-writing of mortgage responsibilities. In Congress they call it a "tweak." It's a disaster. And thanks to all for avoiding the phrase, "Someday this war is going to end." Ooops.
Jack D | 01.29.08 - 2:24 pm | #

AllenM writes:
But Tanta, with the demise of the FICO system now becoming readily apparent, shouldn't a lender attempt to renegotiate the terms to avoid the yawning chasm of cascading cross defaults implied in the race to the bottom that is developing.

More jingle mail means more REO, REO further actively depresses the market, leading to more jingle mail and more REO.

The problem is the disassociation of the end lender into ten tranches with different owners represented by some anonymous chicago trust that uses XYZ loan servicer.

Say my house is now worth 20% under what I owe- would it be in the lenders interest to modify the loan to pay a *much* lower rate of interest on the loan to forgo the potential losses associated with REO?

I would think so, but the phone call from the primary lender has come in yet suggesting a mod that would make *economic* sense.

In fighting the term "ruthless" and trying to substitute something else really implies criticism of the Chicago School of Rational Expectations. Fighting that in today's world is a losing battle. Did you know that research shows teaching undergraduates about rational expectations specifically strips out morality? Check out the literature regarding exposure to rational modeling and the outcomes from prisoner's dilemma in undergraduates.

We have encouraged folks to become sharks, so evincing surprise when they actually begin to follow the models should not be allowd.

Gary Becker is howling with laughter right now at this foolishness.

Someday this war's gonna end...
AllenM | 01.29.08 - 2:26 pm | #

Tanta writes:
If a corporation defaults

These are not corporate loans. Price Stout is correct. The legal documents creating a residential mortgage loan do not make price of the payoff equal to the current value of the property. I don't know how many times I have to say this. You can, if you want, say that the terms of the mortgage loan can be described in options language. That does not mean that these are options contracts.

It means lenders mispriced the risk of no-down lending.
Tanta | Homepage | 01.29.08 - 2:28 pm | #

hdude writes:
Clue me this.
A mortgage contract is not written as an explict "put" option, but isn't the risk spread premium suppose to account for that. If the load was 100% recourse (and collectable), shouldn't the interest rate be equivalent to the conforming rate?
hdude | 01.29.08 - 2:28 pm | #

BG writes:
Tanta,

As an aside, exhibit 2 was a great inclusion. A way to enhance it, to my mind, would be to plot the difference between the 10-year and the MBS as a single graph as a follow-up. It would, of course, look very much like the payoff diagram of an explicit equity put, which I think brings the point home.
BG | 01.29.08 - 2:30 pm | #

HARM writes:
Don't the GSEs & FHA make loans to people with foreclosures, once they've passed the 2-year mark?

Only with documented extenuating circumstances. In other words, only if it's "distress" instead of "put."

To that I say: Congress can --and, when sufficiently pressured, will-- change the rules of the game any time they see fit. There could potentially be millions of people walking way --regardless of whether it's a "distress" walk, or a "ruthless" walk.

How does the old saying go? If you're going to do something stupid, do it in large numbers.
HARM | Homepage | 01.29.08 - 2:31 pm | #

Anonymous writes:
Oh it happened before, but it will be MUCH different this time.

Jingle, Jingle....

http://bp3.blogger.com/ _ym8Q9yxU...si11072peak.JPG
Anonymous | 01.29.08 - 2:31 pm | #

Tanta writes:
shouldn't a lender attempt to renegotiate the terms

Well, I've been arguing for the sense in workouts all year. Often to the howls of outrage of the "moral hazard" brigade, who have been telling me at length that a deal's a deal: you agreed to pay this much and you have to pay it.

On the whole, some of this (say, the hesitant-ruthless borrower) could be solved with lenders just getting over it and cramming themselves down.

Some of it can't be. I don't know if you've ever tried to negotiate with a truly ruthless borrower, but my experience is there's no point to it.

Some genies can't be put back into bottles.
Tanta | Homepage | 01.29.08 - 2:32 pm | #

BG writes:
"Some of it can't be. I don't know if you've ever tried to negotiate with a truly ruthless borrower, but my experience is there's no point to it."

Well, there is _some_ value in not defaulting, even if you come out ahead vis-a-vis your current mortgage. Restricted access to credit going forward isn't cost-free, unless you're moving into a cave without electricity and becoming a subsistence farmer.
BG | 01.29.08 - 2:36 pm | #

Aheadofthecurve writes:
Alright, call me old-fashioned but I never paid much attention to the price of my house either during the boom or now during the bust. I bought a house I like and can COMFORTABLY AFFORD. It is not an ATM nor is it an investment-that is what I have stocks, bonds, CDs and a small business for. It's just my house, which I intend to continue living in unless dire circumstances (fire, flood, grave illness. etc.) force me out. If I wanted to invest in RE, which I don't, I would buy an apartment or commercial building.

Sheesh!
Aheadofthecurve | 01.29.08 - 2:38 pm | #

Allen C writes:
"These are not corporate loans."

I agree, but secured, non-recourse is secured, non-recourse. If I promise to pay regardless, then it seems beyond non-recourse. I must be missing something here. TIA.
Allen C | 01.29.08 - 2:40 pm | #

Zigurrat writes:
The ruthless/dumb couple on 60 minutes were especially upset with the fact that they couldn't refinance but were stuck both upside down and with an 11% interest rate.

Being down $100k @ 6 percent, tax deductible is like an extra car payment.

They were 'dumb ruthless' -- not exactly a position I would like to find myself in.

Anyway, I still think most people with problems will be stressed or distressed -- not the cool, rational smart money that walks without any blowback. Like Donald Trump.
Zigurrat | 01.29.08 - 2:42 pm | #

Tanta writes:
If the load was 100% recourse (and collectable), shouldn't the interest rate be equivalent to the conforming rate?

As long as you factor in the costs of collection.

There is the time value of money. That's actually why conforming GSE pools have some additional value to investors: the GSEs don't just guarantee "eventual" return of principal, they guarantee "timely" repayment of principal. The GSE (or servicer) advances principal to the investor, and then goes and collects it from the borrower. So if you own part of a GSE MBS, you don't have to account for it taking a year to get your hands on your principal in a default situation.

So yes, the GSEs have the pricing problem of setting the guarantee fee. But there's still the "call" issue with conforming vs. jumbo.
Tanta | Homepage | 01.29.08 - 2:42 pm | #

Rob Dawg writes:
Tanta sayeth: Well, I've been arguing for the sense in workouts all year. Often to the howls of outrage of the "moral hazard" brigade, who have been telling me at length that a deal's a deal: you agreed to pay this much and you have to pay it.
This member doesn't see it that way. I've been arguing that a public willingness to do workouts will "create its own weather" and thus expand the pool of candidates for workouts. The hazard isn't in letting some FB "get away" with something. The hazard is to the system that becomes a larger problem by becoming an attractive nuisance.
Rob Dawg | Homepage | 01.29.08 - 2:44 pm | #

AllenM writes:
I have agreed with you as the declines have accelerated that the need for mods is apparent. What is happening is the very disintermediated structure is putting the asset owners at cross purposes and not allowing even hesitant-ruthless borrowers (a class that I probably fit into) a chance to even begin to negotiate.

I think we will see outright capitulation by the mortgage first lienholder brigades with the heloc folks fighting a rear guard action that only delays the inevitable.

Meanwhile, a lot of folks that might have just held their noses and continued to make their payments are going to walk because they feel *housepoor*, and they see a large number of empty houses just sitting on the market in thier area with no progress in clearing the overhang.

That leads to the race to the bottom.

What reasonable thing can you tell an ARM holder facing reset that is now 15% underwater? Too bad, go away?

The sad part is that this bubble, unlike the last stock bubble, took in a whole bunch of folks that would have most likely in the next few years made it as homeowners and allowed the boomers *some* support to their fantasy of selling the old homestead and using the money for a trip to Bali.

Now, no dice.

I think a lot of the moral brigades understands that this *will* impact them as the real estate market will most likely *not* have another bubble in their lifetimes. That realization that real estate is over will be quite painfull in the coming decade, and will make an already angry polity even more grouchy.

Someday this war's gonna end...
AllenM | 01.29.08 - 2:45 pm | #

Anonymous writes:
aotc- Do you have a family that has MANY future $$ needs?
Anonymous | 01.29.08 - 2:45 pm | #

Markel writes:
Tanta wrote

As far as I can see, they're just trying to reflate house prices.

To fix things, they don't need to merely reflate current prices in some way. They need to reflate appreciation rates, too, back up to bubble levels. The promise of future appreciation was the only thing supporting current prices.

I think if the villagers recognized that, even they would choke on it.
Markel | 01.29.08 - 2:45 pm | #

Dirk van Dijk writes:
Tanta,
I'm going to send this post out to everyone I know (including analysts working both here in the U.S. and in India) who is working on their CFA. You summed up in about 10 pages what it takes Fibozzi's "Fixed Income Handbook" about 150 pages to do, and in a much more clear and understandable way. BRAVO
Dirk van Dijk | Homepage | 01.29.08 - 2:49 pm | #

Alpha_Bear writes:
"...please take the time post a graph or table w/ price-to-income ratios for various Canadian cities."

Here's a link which
calculates the ratio of the median house price to the median household income for many cities in the U.S. and Canada.

I'm suspicious about the numbers for Vancouver, since they somehow come up with a median house value of $503,400, while the
Greater Vancouver Real Estate Board states that the value of a "detached" house is $732,320.

I couldn't find anywhere how the first study defined what a house is, but in Vancouver a house is detached, while an attached unit is a townhouse, and an apartment is a condominium.
Alpha_Bear | 01.29.08 - 2:50 pm | #

Zigurrat writes:
"I think a lot of the moral brigades understands that this *will* impact them as the real estate market will most likely *not* have another bubble in their lifetimes. That realization that real estate is over will be quite painfull in the coming decade, and will make an already angry polity even more grouchy."

I am not sure what it would take to put a stake through the heart of the real estate investment thesis. I think most people would still say that housing will cost more in 5 years. Excluding ground zero in the current bubble. Not above the maximum prices but current prices.
Zigurrat | 01.29.08 - 2:50 pm | #

ron writes:
Thanks Tanta very well written.
ron | Homepage | 01.29.08 - 2:51 pm | #

threetorches writes:
Ding! Ding!
Award to lessismore for being the first to say "efficient breach."

And Tanta is correct, bytheway, it IS a breach. Thus damage to future creditworthiness. But we don't drag people out behind the barn and shoot them for breaching a contract. Well, not so much anymore. Dirty rotten contract-breachers. Instead, we just gather what apples we may, based on the safety mechanisms built into the contract. Some lenders are learning that some borrowers price the results of breach differently than others.

Good times.
threetorches | 01.29.08 - 2:52 pm | #

Aheadofthecurve writes:
Your house is a consumer purchase not an investment. If you can afford it and you enjoy its use, then by all means, go ahead. If you want to invest for the future (as you should) than you need to acquire a share in what Marx called "the means of production". That can be stocks, investment real estate (i.e., cash-flow generating property), a business or anything that generates future cash flow.

The fact that so many misunderstood that is the root of the problem.
Aheadofthecurve | 01.29.08 - 2:53 pm | #

AllenM writes:
Rob, we are going to take our pain one way or another, so why not allow folks to keep their palace at a cheaper rate. One of the things I advocate for is simply cutting the interest rates waaay down. Then when the real estate market finally comes back the priciple *will* at least have a chance of being repaid.

These losses to principle through crappy recovery rates are far more devastating in terms of valuing pools than a lower interest rate would be.

That is how you deal with stranded borrowers, not by saying "Oh well, if we give you a deal, then everyone will want it."

Do the deal, and give them cheap interest rates, without changing the structure of the current loan in terms of refi's. Just do the mod and take less interest. Ruthless folks will prepay their mortgages, or they will just pay less and keep spending.

Either way we get what we need, a big slowdown in foreclosures and some economic stability.

The current course is madness, and will lead to a J*s J*in paradise.

Rob, sometimes you just have to accept that the ruthless folks get out and win under the cover of the common man's disaster.

Casey showed that playing the game was darned near riskless in living well for a couple of years on OPM.

Someday this war's gonna end...
AllenM | 01.29.08 - 2:54 pm | #

Anonymous writes:
Alpha_Bear - That is a beautiful report...can also come in handy negotiating contract 'per diem' :)
Anonymous | 01.29.08 - 2:57 pm | #

Tanta writes:
You summed up in about 10 pages what it takes Fibozzi's "Fixed Income Handbook" about 150 pages to do, and in a much more clear and understandable way

My new motto: "I read Fibrozzi so you don't have to."

Actually, I didn't learn about mortgage pricing by reading Fibrozzi (useful as his text is, no question).

I learned about mortgage pricing after having been removed from my comfortable cubicle in credit policy and being escorted to my new cubicle in secondary marketing. As my boss said at the time, "Don't be intimidated. Your new colleagues have better math skills than you do, but since you're the only one in the room who actually knows what these "mortgage" thingies are we're trading, you have a distinct advantage."
Tanta | Homepage | 01.29.08 - 2:59 pm | #

Tony Shifflett writes:
Personally, I don't think people will give two shits whether or not you call this "ruthless", "fascist", or whatever for walking on underwater loans. This is the natural course of events when you get away from solid lending practice.

The banks and Republican ideology is at fault here. The banks and their people are largely at fault because of their ruthless pursuit of percentage. Bush and his minions (think Greenspan and Ayn Rand) took the controls off because that's exactly what they wanted to do. They wanted an economy where control was light to nonexistent, and this is the natural result of all that.

Over the past several years I've become very conservative about finances. I do feel that, if we went back to an educational system that stressed traditional classical education, people might have a more strategic view of these things, instead of the totally operational society we live in now.

Fat chance of that.
Tony Shifflett | 01.29.08 - 2:59 pm | #

Allen C writes:
"If you mean as a matter of law (or fact), you are simply incorrect."

Thanks Price Stout.

If someone lives in a non-recourse location, doesn't the law effectively supercede the contract language? What is the homeowner really signing here?
Allen C | 01.29.08 - 3:01 pm | #

En Fuego writes:
I don't have a problem with the word "ruthless". Hell, I'm willing to bet that some traders on Wall Street would be honored if you called them ruthless :).

Instead of calling a person ruthless, I'd just say she is marking her house ( and mortgage ) to market. If the MTM of this portfolio is negative and she has a *legal* option to exit at zero then that sounds financially rational to me. It might be immoral, but it's hard to argue that it isn't rational.

The one thing people probably don't factor in is the cost going forward. Good luck when she tries to find cheap credit in the future.

It seems to me that the real problem here is a total pricing failure on the part of lenders. They priced the rates on their loans using irrational assumptions about the market. My friends in finance have many colourful phrases for this situation -- "quote the wrong price often enough and eventually someone will rip your face off". lol
En Fuego | 01.29.08 - 3:04 pm | #

jawbreaker writes:
my first comment here to congratulate Tanta on another truly outstanding post! thank you.

Whether termed ruthless or efficient breach, we are talking about breach of a contract which was based on both consideration and mutual assent. Accusing mortgage "sellers" of malfeasance ignores that in many cases the buyers were just as greedy. Not just greedy, but also savvy enough to understand concepts like "cash out", now "upside down" and "putting" (but not "ARM"?). IMHO, nevermind what they're selling, its what you're buying.
jawbreaker | 01.29.08 - 3:04 pm | #

Aheadofthecurve writes:
Alpha-Bear excellent find!

A key finding from the report that everyone should recognize:

Low affordability is driven by restrictions on building, not low interest rates or population growth. Many markets that grew very rapidly in population (Houston, Dallas, Ottawa) remained affordable.
Aheadofthecurve | 01.29.08 - 3:05 pm | #

Markel writes:
Jingle mail is not an efficient breach of contract.

In an "efficient breach," you have to make whole the party to whom you broke your promise.

Lenders are not being made whole when people walk away from loans larger than the value of the security--by definition!
Markel | 01.29.08 - 3:05 pm | #

drdebt writes:
Oh Tanta:

That thinking is so Old school, Bill Clinton era stuff. Remember the new mantra, Yes We Can...Change (and exercise that put!)
drdebt | 01.29.08 - 3:05 pm | #

las writes:
I wonder what Uncle Sam would think of all this. Wouldn't the ruthless borrower owe the IRS for his ruthlessly taken forgiven loan? Would the IRS pursue payment eventually even tho lender would not?
las | 01.29.08 - 3:07 pm | #

Rob Dawg writes:
AllenM writes:
Rob, we are going to take our pain one way or another, so why not allow folks to keep their palace at a cheaper rate.
You mean my palace. Seriously, it isn't theirs and never was and now never will be. We cannot choose to reverse discriminate on the basis of financial acumen lest we become Harrison Bergerons and all devolve to the lowest common denominator.

THE YEAR WAS 2081, and everybody was finally equal. They weren’t only equal before God and the law. They were equal every which way. Nobody was smarter than anybody else. Nobody was better looking than anybody else. Nobody was stronger or quicker than anybody else. All this equality was due to the 211th, 212th, and 213th Amendments to the Constitution, and to the unceasing vigilance of agents of the United States Handicapper General.

Anonymous writes:
Come on aotc...are you recommending construction in the ocean off CA & FL, now? You are truely going over the 'deep' end now.

I'm really starting to wonder if you have ever recently been to any of these states or even Texas, at all. Get a grip.
Anonymous | 01.29.08 - 3:10 pm | #

Tanta writes:
While we're on the subject of workouts, here, let me note that this is why I opined a few weeks ago that you can't get very far trying to do a short sale with a truly ruthless borrower.

If the borrower truly doesn't care what your loss is, the borrower will try to sell the house for $10 to his brother-in-law Verne without a real estate broker to "eat fees."

That's why, whenever you as a servicer are presented with a short sale proposal, you have to slog through the process of verifying that it was an arm's-length deal and the sales price is the best the market will bear. Otherwise all you're doing is making the put that much cheaper.
Tanta | Homepage | 01.29.08 - 3:15 pm | #

Aheadofthecurve writes:
Anonymous-I have been to all of those states. I suggest you READ the report. Affordable housing can be built anywhere. The reason it is not is that existing homeowneres don't want "those people' living near them so they enact minimum lot sizes, restrictions on sub-dividing and on and on. No place in the US grew faster than Texas in the 80s and yet Houston and Dallas are 2 of the most affordable cities anywhere. Even New York is considerably more affordable than LA, SF or San Diego. Now why do you think that is? Think high rises vs endless tracts of single-family houses.
Aheadofthecurve | 01.29.08 - 3:19 pm | #

seminole writes:
Marcus I don't do collections but imo with respect to the judges I practice before they aren't going to let you garnish wages unless you provide them with sufficient facts for them to conclude it won't be detrimental to the deadbeat's dependents. A judgment is no problem but actually leaving a family with no funds? All it takes is one ugly case to hit the papers and the judge is in a world of hurt ... no upside whatsoever for him to grant the requested relief ... generally here in florida you don't sue at all unless there is an insurance company that can pay the damages (unless you are going after really deep pockets) ... never heard of a personal injury lawyer turning down policy limit ... I see this a lot in probate cases where MBNA got a judgment against the deceased, they never actually try to collect the judgment through court action cause no judge in the world is going to garnish a little old lady.
seminole | 01.29.08 - 3:21 pm | #

bacon dreamz writes:
Actually, I didn't learn about mortgage pricing by reading Fibrozzi (useful as his text is, no question).

you mean Fabozzi? or is there a joke there i'm not getting?
bacon dreamz | 01.29.08 - 3:26 pm | #

Peter T writes:
One easy way of seeing that even a non-recourse mortgage is not a put option is looking on the credit report. Excersing puts doesn't leave black marks on the credit report, foreclosures and short sales do.
Peter T | 01.29.08 - 3:28 pm | #

Anonymous writes:
aotc- WHAT? Miami had/has plenty of high rises, remember?

But somehow the financial Ponzi Scheme had NOTHING to do with that or the 50%+ price haircut we are now seeing.

Sheesh! is right.

I forgot, never argue with a ____.
Anonymous | 01.29.08 - 3:31 pm | #

Tanta writes:
you mean Fabozzi?

Yep. I must stop typing with my nose.

There might have been a joke if I had said "Fibonacci."

I don't exactly know what the joke would have been, either, but it would have been pretty funny.
Tanta | Homepage | 01.29.08 - 3:36 pm | #

Allen C writes:
"a non-recourse mortgage is not a put option is looking on the credit report."

The ding on the credit report is part of the premium...
Allen C | 01.29.08 - 3:37 pm | #

Aheadofthecurve writes:
Read the g##d### report. Here it is again.

http://www.demographia.com/dhi-i...hi- ix2005q3.pdf

I didn't say the financing had nothing to do with it. It was necessary to enable prices to get so high. Nevertheless, financing was not sufficient. Land restrictions were essential. Car companies have 0% financing all the time, yet car prices don't go up to the sky. Why? Because they build as many cars as people want to buy.
Aheadofthecurve | 01.29.08 - 3:39 pm | #

bacon dreamz writes:
yes, it would have been funny. probably something to do with a spiral and a pig's tail.

by the way, that's one lazy Pig. he's been in that pool for ages.
bacon dreamz | 01.29.08 - 3:39 pm | #

probert writes:

yes, it would have been funny. probably something to do with a spiral and a pig's tail.

Fibonacci:
1. Mathematitian
2. Spiral-shaped pasta-like dry food, derived from the tail of financial pigs
probert | 01.29.08 - 3:42 pm | #

Tanta writes:
The ding on the credit report is part of the premium...

The premium is supposed to go to the writer of the put.
Tanta | Homepage | 01.29.08 - 3:42 pm | #