[Plain in Spain] Mortgage Defaults Don’t End Obligations, But Ends Default Argument on Moral Hazard
Posted by Jonathan J. Miller -Thursday, October 28, 2010, 1:53 PM
6 Comments
We all understand that when one has “skin in the game”, they are incentivized to minimize or control exposure or risk. Stories of no money down borrowers walking away from homes as strategic defaulters are common fodder in today’s news cycle.
However, in Spain, mortgage defaulters remain on the hook for their obligations yet that didn’t prevent them from getting swept up in the euphoria of the credit boom in In Spain, Homes Are Taken but Debt Stays [NYT]
So the argument that homeowners without “skin in the game” were morally bankrupt is a one dimensional viewpoint since Spain had the same shoddy lending practices we did. In other words, the fact that people would have to pay the loans back didn’t dampen the credit frenzy of the times. Moral hazard, the idea that someone will help you if you get into trouble without significant penalty, is the default explanation for a lot of the credit mess.
In the US, lenders AND borrowers AND TAXPAYERS are paying for the error of their ways but in Spain, the borrower seems to have much more of the burden. In theory that makes perfect sense – they borrowed money and can’t pay it back. However the big question is whether or not deceptive or predatory lending practices were commonplace in Spain during the boom like in the US.
The point in my ramblings dialog here is that even with an embedded payback requirement in the mindset of the spanish borrowers, they still took risks that they didn’t comprehend. This therefore suggests a larger structure economic phenomenon that drove so many people to make poor credit decisions.
Moral hazard isn’t the easy explanation many seem to think it is.
Jonathon – it should also be noted that Spain has been using AMC’s as a buffer between the lender/appraiser since 1983 – its written into their governance. So it appears that we can not blame this one on the appraisers.
Jonathan,
I think if you look deeper you would find that foreclosure does not negate the debt in most of the states in the US. The borrower is credited with the amount the property brings at foreclosure sale and remains obligated to the lender for the deficiency, if any.
I don’t think it is as much of sweetheart deal here as the post indicates and I just can’t believe investor want-to-be-walk-aways are that big of deal either. The real tradegy remains the families who have lost so much without so much of glimmer of hope on the horizon.
My understanding is that the banks here prefer foreclosure to work-outs or short sales for a myriad of reasons that have to do mostly with who is in charge and FDIC subsidies called loss-sharing. Being an appraiser, I am inclined to believe it is of primary importance to the banks that they remain in complete charge of all things financial, but they will not cut off their noses to spite their faces, so they probably have a government safety net in place as well.
It really is disconnnected thinking to have one set of rules for the lender and another for the boroower, but that is the way it is. I continue to apply the thinking that if it was obviously stupid to borrow it was equally stupid to lend. The cost of stupidity must equally be distributed.
Whether a bank pursues its deficiency rights is the bank’s option, unless of course there are strings in the FDIC loss sharing regs which may then be interpreted as a debtor subsidy.
This intersection is one of those places I can’t see around the corner and real estate lender dealings are not at all straight forward.
I’d like to know what the heck is going on here for sure before I ponder too much about whether debtors here are better off than the Spaniards.
I take some sort of weird solace that Spain is facing the same fall-out as we are, but I’d like to see some aggressive restraints put on lenders to avoid a repeat of this crap in the future whether in Spain or elsewhere, and that is not at all happening. Why?
There are lots of clouds including the fact that banks refuse to shortsale at higher prices than they get post foreclosure. It is reported that banks will lose on average 35% on shorts but 50% on foreclosures. People who are really wiped out could file bankruptcy if they are pursued for the deficit. I think the pursuit of the shortfall has not been done due to the backlash it would create here in the USA. It is millions of people.
Richard,
I have previoulsy heard about a differential between short sales prices and those in foreclosure, with foreclosure bringing less. The only explanations I can find are anecdotal and possibly tainted by “sour grapes” embellishments.
Is it true that the FDIC subsidizes the banks with loss-sharing in foreclosure but not in short sale?
If that is true, my conclusion is that the bank actually nets more by completing a foreclosure.
I’ve also heard that the banks won’t participate in short sales because they think it makes them look weak.
Have you been able to find facts in the clouds that explain this?
Banks do net more by completing a foreclosure
So, as far as houses go, the occupant is disposessed and most likely evicted, the bank nets more than if they had worked with the borrower to sell the property and an investor buys the property as an REO?
So from where does the more foreclosure net than short sale net come from? Is the government subsidizing the bank only if it forecloses?
I read the FDIC Q&A about loss-sharing and it seems that is exactly what is going on, but I’m not sure the language actually says that.
So maybe the difference in Spain is that the government doesn’t subsidize the bank.