September 04, 2008

posted by Nate Oman

In this model, are there costs to home-selling neighbors not offset by the corresponding benefits to home-buyers?

Good question. It seems to me that it would boil down to whether the costs associated with a bad credit score are sufficiently high to internalize the costs thrown out on neighbors when borrowers make the decision to walk. I doubt that it does. These are going to be borrowers who already have pretty crappy credit scores, scores that no doubt completely went down the toilet in the period immediately prior to their walking away from the house. Accordingly, I doubt that the hit they take on their credit scores is a huge marginal cost for them. (Remember also, that in brute welfare terms most of the gains to the borrowers in unpaid debts are offset by the lenders' losses.)

This sort of theoretical commentary is agonizingly frustrating. While we have heard all about "jingle mail" in recent months, I have yet to see or hear about one scintilla of empirical evidence that this happens. The hit to one's credit score from walking away is not at all insignificant in our credit-based economy, so while I don't doubt that some small subset of mortgage borrowers have just walked away from underwater mortgages, I doubt the impact is anything like your observations (and many less responsible ones elsewhere) imply. At least you put it in terms of "at the margins," but I suspect the effect is extremely marginal at best.

Are you aware of any empirical evidence (not unsubstantiated anecdote) that jingle mail is a real phenomenon that occurs in more than a fraction of a percent of all cases in California and other non-recourse states (like AZ)?

Jason,

You apparently have a very low agony threshold ;p->

The empirical point is a a fair one, but even so I think that you would expect the non-recourse provision to increase lender instigated foreclosures as well. Without the ability to get a deficiency judgment the bank's incentive on marginal loans in a falling market is to call them and foreclose as soon as possible, and lender with a deficiency judgement is exposed to slightly less risk and so many wait on foreclosure a bit longer. Obviously, this too is just an effect at the margin. Still, the non-recourse provisions may well boost foreclosures that are not "jingle mail." There have been quite a few press reports of folks walking away from houses in California, however, although I have no idea how prevalent the practice is. What we really need is not a big empirical study of jingle mail (although that would be cool), but something that looks at differing regional foreclosure rates, controls for stuff like demographics and local economic trends and to see what effect legal rules have on foreclosure rates. At this point, everything I've seen suggests that causation is just too muddy for anyone to be super confident about the impact of any particular cause. That said, I would quite suprised if the non-recourse laws were shown to have no effect on foreclosure rates.

For one such study suggesting the link between high foreclosure rates and the absence of deficiency judgments see Lawrence D. Jones, "Deficiency Judgments and the Exercise of the Default Option in Home Mortgage Loans, 36 J.L. & Econ. 115 (1993)

One other point: "Walking away from a house" needn't literally mean that I send the keys to the bank and move off, i.e. "jingle mail." I may decide to stop making mortgage payments and live in the house rent free until I get evicted in a foreclosure proceeding. A de jure involuntary mortgage doesn't mean that there hasn't been some voluntary exercise of an embedded option by the borrower.

At the risk of being theoretical, let's consider Chief Judge Traynor's explanation of the policy of the "one-action rule," which was originally enacted in the 1930s: "Section 580b places the risk of inadequate security on the purchase money mortgagee. A vendor is thus discouraged from overvaluing the security. Precarious land promotion schemes are discouraged, for the security value of the land gives purchasers a clue as to its true market value. [Citations Omitted.] If inadequacy of the security results, not from overvaluing, but from a decline in property values during a general or local depression, section 580b prevents the aggravation of the downturn that would result if defaulting purchasers were burdened with large personal liability. Section 580b thus serves as a stabilizing factor in land sales." Roseleaf v. Chierighino, 59 Cal. 2d 35 (Cal. 1963).

A couple points here: one is that in a bubble, land prices are likely to be overvalued. Second, Traynor, J.'s focus is on the signal to the purchaser at the time of the purchase. The shift, then, to "foreclosure is providing homeowners with a very important signal, namely that they borrowed too much money and bought too much house," is an interesting one. This shifts the blame onto the victim. (Nate's advice is also interesting: "The best thing to do is to heed that signal and get yourself into housing that you can afford" -- as if this is so easy when the house you're in is underwater, and credit is tight?)

The idea that California is wrong to allow non-recourse loans ignores the forces that create bubbles to begin with. It's not 75-year-old laws like this that create them.

Nate's post seems to say that not only should purchasers be victimized by bubbles, overpaying for their homes, but also they should be blamed for "buying too much house" when the market reverses. There's no doubt that many buyers were stupid. But if I have to choose between buyers and lenders bearing the risks the one-action rule was meant to address, I think it's appropriate that lenders bear them. They didn't have to grant the loan to begin with.

The bigger problem is lenders' greed, and the ease with which they could package and sell off the loans. If you really want to keep communities together, why not make it more difficult to sell off loans to "arrangers" and others in the securitization food chain? Require lenders to bear the consequences of their decisions more directly, as they used to.

Jason Kilborn has his argument backwards. If someone comes up with a theory, there are two ways to defeat it. First, to show that the theory is internally inconsistent, logically deficient, etc. Second is to show that the theory is rejected by empirical evidence.

Kilborn does not offer any empirical evidence that rejects Oman's theory. And he also does not offer any theoretical reasons to think Oman's theory is wrong. Making some very vague comment about the hit to a credit score is vastly insufficient to defect Oman on theoretical level.

Since Kilborn specializes in bankruptcy law, and fails to present anything damaging to Oman, I take it, Oman is in a great shape here!

Loose credit is sinking the banking ship.
No longer theory, is it.
US govt will have to take over loans here for at least a year.
US govt uses complex transaction reporting systems in some procurement agencies.
Similar ratings systems are being designed and need implementation to properly assess credit risk.
Present credit/loan formulas are lacking proper employment/income risk.
I believe very strongly in statistical surveys and analysis.

This is purely anecdotal, but in my experience as a bankruptcy lawyer in Pennsylvania, a state where it is difficult for a residential lender to obtain a deficiency judgment (and I've never seen one), people find themselves in foreclosure because they are unable to pay their mortgages. I have never seen anyone with the ability to pay decide to turnover the keys just because the house ended up to be a bad investment. The full social, psychological and emotional cost of moving is totally discounted by Omans hypothesis. Oman also makes the unlikely assumption of knowledge on the part of consumers that their financial obligation is non-recourse. My experience says that most consumers assume the opposite.

Since the holder-in-due-course rule provides immunity to lenders from the fraud in the front end of the transaction that led a consumer to sign on for a loan beyond his means, it is fair to limit the lender to the value of the house without allowing the lender to pile it on when the transaction inevitably goes south.