Home Underwater? Walk Away from Geithner's Perverse 'Homeowner Relief' Plan
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So it's no surprise that banks are extremely reluctant to wipe out principal for borrowers in trouble. "If you require principal reductions, that's a big hit to the banks," Baker says. "But a mortgage program where you're even putting up taxpayer dollars to help people pay more than their homes are worth, and paying more than what they'd pay to rent the same place—that's a real gift to the banks. If you ask who wins in this story, well, the banks win."
Borrowers don't usually think seriously about walking away from their homes until their payments become unaffordable. If the bank won't face up to reality, and the Treasury Department insists on looking the other way, walking away can save you a lot of money. And the sooner you walk, the harder it hits your bank—they're hoping you'll take on credit card debt and hit up family members to make a few more payments before you lose the house anyway.
But even people who can afford their monthly payments should be reluctant to give $70,000 or more to a bank for no reason. Walking away from an underwater home—even one you can afford— isn't illegal or immoral. It's written right into the mortgage contract: If you can't pay the debt, the bank gets the house. "Personal responsibility" doesn't mean further subsidizing the banks that your tax dollars already bailed out. In corporate real estate transactions, companies walk away from bad investments all the time. Sure, it's bad for your credit score. But is your credit score worth $70,000? Credit scores eventually recover-- $70,000 doesn't just fall out of the sky.
"There's a tipping point here on borrower behavior that we haven't yet reached," says Date. "When we get there, banks are really going to wish they'd played ball earlier."
There's only one scenario in which the
The decline in home prices has moderated somewhat in recent months, but overall, home prices are down about 30 percent from their bubble-peak levels, according to the Standard & Poor's Case-Shiller home price index. If prices were to suddenly surge and make back those losses, then millions of currently underwater borrowers would find themselves in a much more profitable position.
Economists are split about how much further home prices have to fall. But there's little reason to believe that home prices are going to shoot up. The very definition of a bubble is a situation in which prices are artificially elevated.
"People are talking about how they're going to bounce back, and it reminds me of when the NASDAQ plummeted from 5,000 to 3,000 back in 2000," Baker says. "All these people were talking about how it was going to come back, and I just don't know what they were smoking....It's just wishful thinking without any basis in reality."
So if home prices aren't going to suddenly skyrocket for no reason, then we're going to see a lot of foreclosures. And it will be better for borrowers and the economy to walk away sooner rather than later—they'll have more money to spend on other stuff.
Of course, the best solution here would be for Congress and the Administration to make the banks recognize the losses they're going to take from their bubble lending without making you move. Treasury doesn't have a whole lot of leverage over major banks now that it has allowed them to pay back the funds they received under the Troubled Asset Relief Program. But if Congress would change the consumer bankruptcy laws to allow mortgage debt to be renegotiated in bankruptcy court, we could get the same effect from a judge. The fact that mortgage debt is exempt from ordinary bankruptcy proceedings has always been both bizarre and unfair.
"If you really were serious about reducing foreclosures, you would do it by refining the consumer bankruptcy process," says Raj Date. "Bankruptcy is the legal mechanism by which we weigh the competing claims of different stakeholders."
Congressional leaders tried to change the bankruptcy laws last year, but President Obama did not fight for the measure, and the bill succumbed to a filibuster launched by Republicans and corporatist Democrats.