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Think like an amoral banker

From Ft.com:

Jeff Horton has a job, two cars and money in the bank. Yet, he stopped paying his mortgage a year ago. With shoddy documentation by mortgage lenders now delaying foreclosures across the US, Jeff thinks he will continue living for free for at least another six months, and probably longer.

The 33-year-old IT specialist is keen to put an end to his disastrous home purchase that will likely leave his bank with a loss of at least $100,000. Until the bank actually makes him leave, he will keep living in the Orlando house, and pocket the $2,200 he used to pay on his monthly mortgage. “I’m not stupid,” he says. “I will live for free until the bank takes over the house.”

Shasta Gaughen, an anthropologist living in California, stopped paying her mortgage in February. She has no idea when her home will actually be taken over. “I have been able to save significantly,” she says. “Every penny that was supposed to go to my mortgage went into savings, around $1,200 a month.”

Both Mr Horton and Ms Gaughen are the types of people banks like to lend to. They made payments on time, they have jobs. However, the plunge in US house prices – which has been particularly severe in California and Florida – left both of them with mortgages worth much more than their homes. Not having put any of their own money into the homes – 100 per cent financing was a common feature of the housing bubble – they decided to walk away from their mortgages.

Historically, homeowners have been reluctant to do this. Part of it reflects the fact that people want to “do the right thing”. “Borrowers are likely to stay in their houses until they are well beyond the book value underwater mark,” a Federal Reserve Bank of San Francisco analysis said this week.

Whether more of the millions of homeowners now facing “negative equity” decide to follow the path of Jeff and Shasta is making plenty of banks, regulators and investors very nervous. More defaults, especially by people still making monthly interest payments, increases losses for banks and the investors owning billions of dollars of securities backed by mortgage payments.

A particular worry is whether the tales of shoddy documentation completed by so-called “robo-signers” at mortgage lenders and growing foreclosure delays will affect people’s behaviour. It could for three reasons.

First, a longer gap between stopping payments and being evicted from the property allows people to build up a nest-egg. In many states, homeowners do not owe the bank anything more than the keys to their home if they default on a mortgage.

Second, a slowdown in foreclosures creates an ever-growing backlog of unsold homes, which will at some point be sold, pushing house prices lower. If people think home prices will not recover, they are more likely to throw in the towel.

Third, it further damages the reputation of the banks who made the mortgages, and this could make borrowers more unwilling to pay. “More bad news and uncertainty creates more anger against the banks and frustration with the system,” says Chris Mayer, Professor at Columbia Business School. “That’s not helpful.”

Indeed, Jeff tried to get his bank to reduce his monthly mortgage payments so that he could rent out the property. The bank was inflexible. When he read about million-dollar bonus payments to bank executives last year, he decided to stop making payments. “The bonuses were the last straw,” he says.

Jon Maddux, who runs YouWalkAway.com, which advises people on the foreclosure process, says calls about foreclosures have increased recently. “The banks are cutting corners in the foreclosure process and in some cases breaking the law and that sends the message to homeowners that, if the banks are not honouring their promises, why should the homeowners?” he says.

Regulators are trying to work out if the documentation problems create added risks for banks. There is an assumption that borrowers with good credit histories will keep paying. If that changes, there could be another wave of losses for the financial system.

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