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Acts of Greater Courage

Shawn Gravelin, a manager in Allonhill’s credit risk management group, has guest written this blog post.  He and other guest writers will appear in the Allonhill blog from time to time.  His post appears below.

Acts of Greater Courage
By Shawn Gravelin

On June 23rd 2010, taxpayer-owned Fannie Mae announced its intentions to “lock out” or prohibit homeowners from obtaining new Fannie Mae-backed mortgages for the next seven years if they’re guilty of strategic defaults, a process in which homeowners choose to default on the loan despite having the means to make payments.

Terence Edwards, Fannie's executive vice president for credit portfolio management states, “defaulting borrowers who walk away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure.”   

In researching the issue, I was stunned by the volume and veracity of opposing opinions to the new mandate.  The terms used are “war,” “threats,” “shame,” and “punishment” as opposed to the innocuous “walk-away.”  I can’t help but picture a glorious orange sunset accompanying a borrower who decided to walk away, presumably to secure another mortgage at a more reasonable price.  But I have to admit, I’m sympathetic to their plight. 

Credit was easy; the array of mortgage products allowed borrowers to get much more house, and those products became more complex.  Unfortunately, this precursor was followed by a recession, high levels of unemployment, and plummeting housing values.   Now with taxpayer-owned Fannie Mae trying to lock out borrowers guilty of strategically defaulting, are we trying to put out the fire with gasoline?  No, and here’s why.

It’s obnoxious to call Fannie Mae “taxpayer-owned Fannie Mae,” but it’s also important because YOU as a taxpayer should not want Fannie Mae guaranteeing loans (with your money) for borrowers who could afford a property, but choose not to fulfill their obligation.  If the issue is viewed simply as a business decision or a tolerance for risk, the question of morality goes out the window.  Would you want to be guaranteeing a pool of loans that contain loans with or without borrowers who have strategically defaulted?    I think not.

The second piece of this puzzle is why would anyone care about hurting the Wall Street investment banks that gambled recklessly while paying huge bonuses to themselves? The answer is because people think they are sticking it to the banks by strategically defaulting on their mortgages.  You first need to ask yourself where the bank gets its money.  More specifically, where did the bank get the money to loan you for your mortgage?  A bank will originate a mortgage, then turn around and sell that mortgage (along with a lot of other mortgages) on the secondary market to investors in mortgage-backed securities.  The investors purchasing these mortgages are the same people that provided you the opportunity to secure the credit needed to own your piece of the American Dream.  This ranges from institutional investors representing pension funds and retirement accounts, to hedge funds, to individuals; the point is that it’s not the banks’ money and by walking away, you are not hurting them, you’re hurting the investors.  When this lending mechanism breaks down and there is no secondary market where banks can unload mortgages they’ve originated, credit dries up and no one gets loans.  Even if the bank is left holding loans, it’s the shareholders that hurt.

It’s easy to be upset when a CEO and his or her entourage get bonus checks for millions of dollars while leaving blood in their wakes.  I’ll go a step further, it’s understandable.  Unfortunately, strategic defaults don’t cause pain where you might want it felt.   It raises your taxes, and hurts your pensions and retirement accounts. 

The term “lockout” has an ominous ring to it.  It sounds punitive and harsh, but the truth is that if a borrower chooses to walk away from a mortgage without picking up the phone and seeing what other options are available, then a seven year lockout from Fannie Mae is a slap on the wrist.  Though the measure proposed hardly has teeth, what Fannie Mae really wants is for borrowers, who are in the midst of making difficult decisions, to pick up the phone and talk to their servicers about loss mitigation options.  If someone doesn’t want to keep his or her home and is willing to walk away, then a short sale or “deed-in-lieu” might accomplish the same goal while having less negative credit impact on the borrower, preventing deficiency judgments, and having additional credit available (not to mention saving your fellow Americans money).  If you were considering walking away from your mortgage, but would stay if your balance, monthly payments, or interest rate were lowered, then these options are available too.  

Fixing the mortgage mess is more difficult than the masses walking away from mortgages and letting capitalism sort out the rest.  It requires acts of greater courage than strategically defaulting without exploring all the options.  Ultimately, the law of supply and demand is working (albeit slower than we would like).  New and increasingly creative modifications and borrower exit strategies are being implemented, but there is no supply without demand, and if you choose to strategically default, then you really are demanding not to be held accountable and to be forgiven if circumstances change outside of your favor.  With all of us paying for those losses, I think it’s only fair that precautions be taken by institutions like Fannie Mae – sorry, make that taxpayer-owned Fannie Mae.