Strategic Defaults Threaten Housing Recovery

One of the biggest concerns weighing on the housing recovery remains the threat from “strategic defaults” by underwater homeowners (estimated at 25% of US households). With the backlog of foreclosures overwhelming the capacity of banks and mortgage servicers to deal with them, many homeowners are able to live rent free for months and potentially years on end. As suggested in the chart below, the average time it takes for a defaulting household to actually lose their property through a foreclosure has increased 75% since 2008 from 251 days in January 2008 to a staggering 438 days as of April 2010. The most egregious state is New York where the average homeowner spends 561 days in foreclosure, following closely by Florida at 518 days. Understaffing banks, government pressure to offer modifications, and incessant legal challenges have allowed millions of homeowners to live rent free, which in my opinion is creating an artificial boost to consumer spending, despite persistently high unemployment. With $2,000 or so freed up from not having to pay one’s mortgage, much of that money is being directed into other parts of the economy.

Some great quotes from a New York Times article (“Owners Stop Paying Mortgages, and Stop Fretting”) on the subject include the following (note how easy the profiled people are able to rationalize walking away from their contracts):
- More than 650,000 households had not paid in 18 months, LPS calculated earlier this year. With 19 percent of those homes, the lender had not even begun to take action to repossess the property — double the rate of a year earlier.
- One reason the house is worth so much less than the debt is because of the real estate crash. But the couple also refinanced at the height of the market, taking out cash to buy a truck they used as a contest prize for their hired animal trappers. It was a stupid move by their lender, according to [the homeowner] Mr. Pemberton. “They went outside their own guidelines on debt to income,” he said. “And when they did, they put themselves in jeopardy.”
- Foreclosure has allowed them to stabilize the family business. Go to Outback occasionally for a steak. Take their gas-guzzling airboat out for the weekend. Visit the Hard Rock Casino. “Instead of the house dragging us down, it’s become a life raft,” said Mr. Pemberton, who stopped paying the mortgage on their house here last summer. “It’s really been a blessing.”
- In Pinellas and Pasco counties, which include St. Petersburg and the suburbs to the north, there are 34,000 open foreclosure cases, said J. Thomas McGrady, chief judge of the Pinellas-Pasco Circuit. Ten years ago, the average was about 4,000. “The volume is killing us,” Judge McGrady said.
- About 10 new clients a week sign up, according to Mr. Stopa, who says he now has 350 clients in foreclosure, each of whom pays $1,500 a year for a maximum of six hours of attorney time. “I just do as much as needs to be done to force the bank to prove its case,” Mr. Stopa said.