Foreclosure Numbers are High But the Mortgage Default Rate is Modest

There is a paradox – while foreclosure numbers are high, the mortgage default rate is modest. Millions of owners of residential houses have gone underwater – the value of their houses having fallen below the loan amount. In Nevada over two thirds of the borrowers are in this zone. Yet the majority is regularly meeting their mortgage dues despite innumerable financial incentives for them to walk away from these mortgages.

A borrower who financed the purchase of a home in 2006 in for $600,000 could now find himself or herself in a peculiar position with the property value fallen to $3,000,000 – it being less than the loan amount. The situation has become such that by paying an amount less than the mortgage amount the borrower could live in rented quarters. It would mean thousands of dollars saved per year.

Despite this topsy-turvy situation many continue to pay for ethical considerations. This view is being pushed by the government – especially from the time when Henry Paulson was the Secretary of the Treasury. He had commented that anyone walking away from mortgage dues would tantamount to be “simply a speculator – and one who is not honouring his obligation.” It is ironical that a former investment banker should be maligning speculation!
But the question remains whether it is simply ethics that is tying down the people to their underwater mortgages.

Professor Brent White of University of Arizona has alleged that the people are actually victims of ‘norm asymmetry.’ This means they are tuned to think that even if it goes against their financial interests they have to repay the loans. On the other hand the lenders have the freedom to do whatever rakes in maximum gains. It can be compared to two sides playing poker wherein only one side thinks that bluffing is immoral.

If the lender had been the local banker this sort of thinking would not have been out of place. But the majority of the recent loans had been initiated by ferocious brokers who maximized on the fees squeezing out costs from the borrowers. The loans on the other hand were packaged and sold to investors who were hopefully of greedy returns on mortgage backed securities.
The ethical argument does not hold good especially in states like California and Arizona where the mortgages are non-recourse ones. It means the loans are secured by the property only. In the case of a default the lender has no claim on the other possessions of the borrower. These mortgages are financial transactions where the borrower has the clear option of giving the lender the property and then walking away.

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