Fannie Mae has introduced a new policy that prevents people who have defaulted on their mortgages from getting a new Fannie Mae loan for seven years – up from five previously. This policy only applies to defaulters who have adequate income and other resources to pay the note – a process Fannie Mae calls “strategic defaulting.”
On the face of it, this is pretty silly. The Daily Caller, in its tongue-in-cheek manner, explained the policy this way: “You cannot steal from us again for a VERY long time. But then you can!” And it seems unlikely that people who were not dissuaded from defaulting by a five-year waiting period will somehow feel compelled to pay up because the waiting period is seven years.
The Wall Street Journal reports this policy change is prompted because many people are under water on their mortgages:
Fannie's move comes amid greater concern that it has become socially acceptable for borrowers to stop paying their loans, and that such a shift could exacerbate the housing bust. Those worries are particularly acute in Arizona, Nevada, Florida and other hard-hit housing markets where it could take years for borrowers to return to positive equity.
Nearly one in four homeowners with a mortgage is underwater, or owes more than their home is worth, according to CoreLogic, a real-estate data firm. A Morgan Stanley report estimated that around 12% of all mortgage defaults in February were strategic.
The same Wall Street Journal article quotes a Fannie Mae executive pronouncing on the trend:
“Walking away from a mortgage is bad for borrowers and bad for communities, and our approach is meant to deter the disturbing trend toward strategic defaulting,” said Terence Edwards, Fannie's executive vice president for credit portfolio management.
Mr. Edwards’s assessment is completely self-serving. It is indeed bad for Fannie Mae if people don’t pay their mortgages. It is not bad for borrowers to walk away from mortgages when they would simply be putting good money after bad – that is why they walk away.
And conservatives should be cautious about treating these strategic defaulters as morally culpable. The Daily Caller gave its witty take on Fannie Mae’s new policy this way:
The aggressive policy… is meant to curb "strategic defaulting," in which borrowers realize that they are idiots who paid too much during a bubble, then decide, "Hey, I'm just going to stop paying for this place, even though I have enough money, because I am tired of being a responsible adult."
This may sound clever but the attitude misrepresents the situation and therefore allows Fannie Mae to get away with what are basically PR moves rather than substantive policy changes that will protect taxpayer dollars in the future.
The “idiot” is not the mortgage holders, it is Fannie Mae -- either for not pursuing its rights or buying mortgages that were non-recourse loans.
Contracts of all types typically include either explicitly or by the incorporation of law the penalty for ending the contract early. You might sign a lease and it might be a ten-year lease but give the tenant the right to cancel at any time by paying six months’ rent. A tenant who seizes that option to get out of its lease is not behaving unethically.
Every mortgage out there is either a recourse or non-recourse mortgage -- meaning that the lender either has or does not have the right to sue to recover any deficiency owed to the lender after the house is sold. If the deal was that it was a non-recourse loan, then turning over the keys to the bank is not immorally breaking a deal – it is part of the deal.
Some states have placed limitations on or blocked the ability to claim deficiency judgments. Normally this would cause mortgage rates to soar or make mortgagers demand higher down payments because it is exactly the same as giving every buyer a “put option” on his home. It is giving a mortgage that says, “If this property value keeps going up, the homeowner gets to keep it, but if it goes down he can ‘sell it’ to the bank at the then-current mortgage value.”
One reason this hasn’t happened is that Fannie Mae buys up mortgages without regard to the legal status or right of the mortgagor to claim a deficiency judgment.
If Fannie Mae is serious at all about stopping “strategic defaulting,” it needs to do three things:
1) In each and every case in which a mortgage allows Fannie Mae to pursue a deficiency judgment, it must, as a matter of policy, do so. If Fannie Mae judges the likelihood of recovery to be too low to justify a lawsuit, it must offer its right to pursue a deficiency judgment at auction and see if others think it is worth something. It must do this both because it has an obligation to taxpayers to pursue the maximum recovery possible and to set a clear policy so people will know that they can’t just walk away.
2) Fannie Mae must only initiate or purchase mortgages that specifically give the note-holder the right to pursue a deficiency judgment.
3) Fannie Mae must refuse to initiate or purchase mortgages in jurisdictions that prevent it from pursuing deficiency judgments. In other words, one of the costs for a state that imposes or maintains such laws is that they won’t have Fannie Mae supporting the mortgage market in that state.
This would show seriousness about preventing the kind of “strategic defaults” that plagues the market today, whereas the move to a seven-year recidivism standard is a gimmick.
If the thought is that this is too harsh, these policies could be combined with another: A requirement that mortgage issuers, at the time of origination of the note, offer the mortgagee the opportunity to purchase, at a declared price, a put option on the property. It would be interesting to see how many consumers would actually be willing to part with money to have the right to sell their homes at mortgage value at any time.
In any case, ending “strategic defaults” on federally supported mortgages will save the taxpayer money and lead homeowners to consider more carefully the obligations they undertake. Both outcomes devoutly wished. And both outcomes unlikely to be obtained by a seven-year gimmick.