Do loan owners feel invested in their communities?

A recent federal reserve report suggests a suggestion between equity and community belonging. Does that mean underwater borrowers are invested less?

Irvine Home Address … 14 FREEDOM Pl Irvine, CA 92602

Resale Home Price …… $779,900

Well I lived on the outskirts of town

In an eight room farmhouse, baby

When my brothers and friends were around

There was always somethin' doin'

Had me a couple of real nice girlfriends

Stopped by to see me every once in a while

When I think back about those days

All I can do is sit and smile

John Mellencamp — Cherry Bomb

My strongest feelings of home still reside in my home town in central Wisconsin. It's not a place I can indulge my entitlements, so I find myself wandering the globe looking for a place I can have the closeness of community and the conveniences of modern society. Irvine is as close as I have come.

For many, if not most, a sense of community starts with buying a home. The ability of Americans to buy homes depends on their ability to obtain mortgages. The future of home lending is being debated in Washington now, and the future prices of homes could be greatly impacted by the outcome.

The Future of Mortgage Lending

Narayana Kocherlakota – President

Federal Reserve Bank of Minneapolis

Minnesota Emerging Markets Homeownership Initiative Workshop

Federal Reserve Bank of Minneapolis

Minneapolis, Minnesota

April 5, 2011

Download PDF


… Let’s turn back the clock for a moment to the second half of 2006. At that time, firms and people around the world held a wide array of financial assets that were ultimately backed by U.S. residential land. (Think, for example, of mortgage-backed securities or any asset backed by mortgage-backed securities.) They viewed those assets as being largely free of risk. Investors may have understood that a fall in the value of U.S. land would impose large losses on them. However, they put low odds on such a decline taking place. Rather, they seemed to believe that U.S. land prices would continue to rise at a steady clip.

By the second half of 2007, that belief began to unravel in the face of incoming data. People were beginning to learn the hard way that U.S. land was a risky investment. Now the only question was how risky. The uncertainty about the answer to this question planted the seeds for a global financial panic.

What do I mean by the term “financial panic”? Financial panics are events that blur the line between liquidity and solvency. A firm is solvent if its revenues (in a discounted present value sense) exceed its expenditures. A firm is liquid if it is able to raise enough funds—either by borrowing or by selling assets—to pay its current costs. In a well-functioning financial market, solvent firms are typically liquid, because they are able to borrow against their future profits. In contrast, in a financial panic, lenders feel unable to assess the future profits and/or collateral of borrowers. Borrowing becomes highly constrained, and even highly solvent firms may become illiquid.

The dilemma for lenders during a panic is to determine who is solvent and who is not, that's why all the liquidity dries up. No lender wants to pour money down a black hole.

Lending is sometimes characterized as a confidence game: if lenders all believed firms were solvent, they would be solvent because even the unsustainable Ponzi ventures would be sustained by more borrowed money.

Lending is a confidence game with regard to solvent institutions. When lenders lose the ability to discern between those who are insolvent and those who are not, they stop all lending: a credit crunch.

The federal reserve and the US Government came up with a solution. By declaring insolvent institutions solvent by decree, government makes some firms too big to fail, and it makes the US taxpayer responsible for plugging a hole in our economy that threatens to bring down our banking system.

During the mid-2000s, many forms of collateral around the world were either implicitly or explicitly backed by U.S. residential land. As I’ve described, beginning in mid-2007, it started to become clear that this asset had more risk than financial markets had originally appreciated. It was not clear, though, how much more risk was involved. As a result, financial markets became increasingly uncertain about how to evaluate assets backed by U.S. land. That uncertainty translated into uncertainty about the ultimate solvency of institutions holding those assets—and the ultimate solvency of any of those institutions’ creditors.

Here is where the confidence game interpretation becomes dangerous. This banker is describing this situation as if land is really worth what people were paying in 2006, and if the confidence game had not been disrupted, prices would still be there. That isn't reality.

The reason financial markets ware unsure how to value mortgage-backed securities is because the value of the house was grossly distorted by the financial products of the bubble. With the air abruptly removed from mortgage balances, prices were destined to fall.

As investors became more concerned about the quality of mortgage loans, the secondary market for private-label mortgage-backed securities nearly disappeared. As a result, about 90 percent of mortgages originated over the past two years were guaranteed by government-controlled entities such as Freddie Mac, Fannie Mae, the Federal Housing Authority, or the Veterans Administration. Investors are willing to purchase mortgages and mortgage-backed securities from these agencies mainly because they have faith that the federal government stands behind those instruments.

The only reason private investors are paying prices that permit 5% interest rates is due to the government backing. If investors had to price risk into the market, as they do with jumbo loans, interest rates would be significantly higher.

This heavy reliance on government guarantees is not a sound long-term strategy. Over time, our country needs a mortgage market that returns to greater reliance on private risk-taking and private risk assessment, along with the enhanced regulatory oversight that is already in place. And, in fact, discussions are currently taking place on suitable options for bringing more private capital back into the mortgage market.

Even more generally, I believe that as a country, we need to take this opportunity to rethink many aspects of our public policy programs in the context of housing finance. Home ownership has long been part of the American dream, in no little part because home owners have invested not just in their houses but in their communities. But, through the mortgage interest tax deduction and other programs, we are encouraging people to buy homes by taking on debt—and sometimes large amounts of debt. If we truly want to encourage home ownership, we should contemplate programs that provide incentives for individuals to save and become equity holders in their homes—and, by extension, in their communities….

Are loan owners equity holders in their communities?

The argument used by policymakers for a wide range of government home-ownership assistance programs is home ownership quiets social unrest. People don't riot in a community they feel a connection with.

At some level, there is truth to the idea that people with a feeling of ownership take better care of things. Does owning a home create a feeling civic pride?

Let's assume that it does. The effect may be small, but civic pride is emotionally satisfying, and it tends to get incumbents elected to office, so policies that promote civic pride are favored by government.

What is truly important for civic pride? Does the manner in which a house is occupied have a major impact on civic pride?

If fee-simple title holder with no mortgage encumbrance — a true home owner — feels civic pride as an extension of their ownership, it is likely that mortgage holders also feel this pride in home ownership and community even though their actual ownership claim to real estate (equity) may be very small. The feeling of ownership is only loosely tied to a claim to an asset of tangible value.

In the case of underwater home owners, their claim to real estate has no current liquidation value. For their own personal balance sheets, the property still has option value — their position may have liquidation value again in the future if prices go back up and they have equity again. This option value is the dangling carrot of hope that keeps debtors on the hamster wheel to service the debt. When debtors lose this hope, they strategically default.

The lending line of support in Irvine has been holding median mortgage balances in a tight range since the credit crunch in late 2007. That level of lending is holding the median sales price about 20% below the peak. At that price level, peak buyers are right on the cusp of going underwater.

Once prices drop below the previous median loan peak, the cascade effect of strategic defaults pounds market prices back to the stone ages. This is the lending cartel's greatest fear. Based on the tendency to strategically default, I deduce that loan owners do not have a deep bond with the community at large — or at least not a bond that prompts them to take one for the team.

What about renters?

As a renter, I often ask myself what my connection to the community really is. Like loan owners, I have no equity stake in Irvine real estate. And like a loan owner's option value, I have an intangible freedom value they do not enjoy.

I feel as part of the community as anyone. Being the writer of this blog for four years, I have woven myself into the local fabric. I recently moved to Woodbury, and I feel very comfortable and at-home here. As a renter, I can attest to the possibility of renters for community involvement and a feeling of belonging.

Home ownership does not define one's sense of community.

They waited until the equity was gone, then they foreclosed

When banks stopped processing all mortgage delinquencies as they happened in early 2008, they had to establish buckets of similar loans and determine what to do with them.

One such bucket is composed of properties where the mortgage holder is delinquent, but they still have significant equity. Lenders have no urgency to foreclose on this group because as long as their is equity, they can foreclose whenever they want and still get paid in full. In fact, since they profit on all the fees and late charges, they have incentive to drag the process out until the loan balance is large enough to consume all equity.

That is what the lender did on today's featured property.

The property was purchased on 4/23/2004 for $900,000. The owner overpaid using a $595,000 first mortgage and a $305,000 down payment. Savvy cash buyer, right?

On 6/29/2004 she got a $100,000 HELOC, but it doesn't appear to have been used. On 12/27/2005 she obtained a $55,000 stand-alone second.

By late 2005, this property only had $650,000 in debt, and at the time, it was likely worth much more than that. In late 2007 or early 2008, she went delinquent on the first mortgage.

Foreclosure Record

Recording Date: 04/22/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 08/28/2008

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 05/08/2008

Document Type: Notice of Default

Wells Fargo was the loan servicer, and they foreclosed on 12/7/2010 for $713,932 — the outstanding balance on the first mortgage.

During the time this debtor was delinquent, the loan went from less than $600,000 to more than $700,000. The lender let them squat until their equity ran out, then they foreclosed.

There was no free lunch for this borrower.

Irvine House Address … 14 FREEDOM Pl Irvine, CA 92602

Resale House Price …… $779,900

House Purchase Price … $900,000

House Purchase Date …. 4/23/2004

Net Gain (Loss) ………. ($166,894)

Percent Change ………. -18.5%

Annual Appreciation … -2.0%

Cost of House Ownership


$779,900 ………. Asking Price

$155,980 ………. 20% Down Conventional

4.84% …………… Mortgage Interest Rate

$623,920 ………. 30-Year Mortgage

$158,557 ………. Income Requirement

$3,289 ………. Monthly Mortgage Payment

$676 ………. Property Tax (@1.04%)

$125 ………. Special Taxes and Levies (Mello Roos)

$162 ………. Homeowners Insurance (@ 0.25%)

$0 ………. Homeowners Association Fees


$4,252 ………. Monthly Cash Outlays

-$798 ………. Tax Savings (% of Interest and Property Tax)

-$772 ………. Equity Hidden in Payment (Amortization)

$289 ………. Lost Income to Down Payment (net of taxes)

$195 ………. Maintenance and Replacement Reserves


$3,166 ………. Monthly Cost of Ownership

Cash Acquisition Demands


$7,799 ………. Furnishing and Move In @1%

$7,799 ………. Closing Costs @1%

$6,239 ………… Interest Points @1% of Loan

$155,980 ………. Down Payment


$177,817 ………. Total Cash Costs

$48,500 ………… Emergency Cash Reserves


$226,317 ………. Total Savings Needed

Property Details for 14 FREEDOM Pl Irvine, CA 92602


Beds: 5

Baths: 3

Sq. Ft.: 2550


Property Type: Residential, Single Family

Style: Two Level, Traditional

Year Built: 2000

Community: 0

County: Orange

MLS#: P772387

Source: SoCalMLS

Status: Active

On Redfin: 31 days


Bank Repo! Fresh interior two tone paint and new carpet. Beautiful 5 br 3 ba pool home value priced for quick sale! Spacious living room, dining area, separate family room with granite fireplace and plantation shutters, open & bright kitchen with granite counters and center island, gorgeous distressed hardwood floors throughout, one bedroom and bath downstairs, master suite with granite tile floor master bath, dual sink vanity, separate tub and shower, tile roof. Super motivated seller. Submit!!!

26 thoughts on “Do loan owners feel invested in their communities?

  1. winstongator

    Great post. You nailed it by saying that it was not a confidence issue. The problem was once home prices turned, in summer 2006. At that point you started to get defaults, because the option to refinance was diminishing. Kocherlakota fails to note that it was not just falling home prices that would cause the securities to fail, but stagnant prices would also cause them to fail. I wonder why he leaves that point out? To bolster his weak ‘confidence’ story?

    There are lots of non-mortgaged owners of homes that are not connected at all to their neighborhoods or communities. Areas with vacant unmaintained homes (I know those don’t exist in the HOA land of Irvine) or slumlords would be two. I would also say that people who buy real estate solely for the speculative capital appreciation are less connected to a community than occupants, renters or owners. Do you think the people who used 100% financing to buy a speculative Miami condo care that when they stop paying their condo fees, they’re stiffing their neighbors? This is a real serious problem in SoFla. As for others not connected to their community, you can put massive property developers who use tainted products in their homes (Chinese drywall?).

    Communities existed before common people owned land, and they exist in pure rental areas. ‘Ownership’ is neither a necessary or sufficient condition for building a community.

  2. Planet Reality

    “My strongest feelings of home still reside in my home town in central Wisconsin. It’s not a place I can indulge my entitlements, so I find myself wandering the globe looking for a place I can have the closeness of community and the conveniences of modern society. Irvine is as close as I have come.”

    Have you tried the surrounding town 5 to 15 miles from Irvine? I think you’ll find these areas as being a lot more communal than Irvine. I view Irvine as a cold place that has become somwhat segregated racially. I agree with you though, this general area is tops for finding good long term opportunity and balance in life.

      1. Planet Reality

        I fear this will turn into a racial discussion which was not my goal.

        There is something to be said for the value of diversity in a community. Other OC towns that may be more communal to some have less diversity than Irvine. Also there is a difference between “fresh off the boat” diversity, and longer term American diversity. For some Irvine provides the best communal feel, but IR may feel stronger community else where around Irvine.

        1. Woodbury Renter

          You have to think of Irvine by its communities, and each has very different culture and demographics. Woodbridge couldn’t be any more different than University Park, and both are completely different than the newest communities in the Woodbury area.

          1. matt138

            grew up on a street with 8 houses: 2 korean, 1 jamaican, 3 white, 1 hispanic, and 1 old white homosexual couple. Neighborhoods that lack diversity scare me.

  3. wheresthebeef

    Someone actually paid 900K for this box in early 2004. Don’t even know what to say about that…

    This place gets a 2.5 on the curb appeal 1 to 10 scale. I’m sure the FCBs are foaming at the mouth to scoop this baby up!

    1. tenmagnet

      They’re already lining up under the FCBs Welcome banner at Stonegate.
      Tomorrow is the big Grand Opening.

  4. FreedomCM

    I love that the re-litter can’t even get the year the box was built correct.

    Houses in this tract (and this is the definition of tract housing, imho) appear to have been built in 1998, and sold around300k.

    How in the world are they “worth” $800k now? Not that it won’t sell for that, but is that a long-term sustainable price? (ie a lawyer or physician earning $250k/yr wants to live here?)

  5. Laura Louzader

    A $250K salary ought to buy a person a much better lifestyle than this. What a sad, degrading way to live for anyone who makes a good income. This house looks like it was built from a cardboard kit.

    I make far less, and I wouldn’t settle for this. And I don’t have to settle it as Chicago’s wrecked condo market is offering up truly beautiful condos well within my price range.. and the prices are still falling in this overbuilt market.

    Irvine seems to have a lot of price resilience due to the affluent demographic there, but I’m betting that you all will see more price breaks in choice housing as the recession grinds on to its second leg down. We are NOT out of the woods yet, grasshoppers, and there is still a lot of shadow inventory in every housing market in the country, including “flyover” places that were supposedly unaffected by the bubble.

    1. Planet Reality

      Boy oh boy, you would not want to see what the renters earning $80k per year here are living like.

      Yes we understand Chicago had a bubble, it’s not a flyover area, you sometimes have to change planes and deal with that horrible airport mayhem.

      By the way, thanks again for helping to pay for California’s “problems”.

      1. HydroCabron

        I have scanned your post thoroughly for content.

        I can report that no content was detected. Nothing there but venom and comma splices.

        1. bigmoneysalsa

          True that, Hydro. You’re not suprised, I hope.

          I rent in Irvine and am in that general income range. Between my 5 minute commute and all the disposable income I have because I chose not to buy when I moved here, my lifestyle is pretty great! Irvine is a wonderful place for upper middle class households like mine, as long as they take the simple step of not buying during an housing bubble.

      2. winstongator

        PR, California pays a lot more in federal taxes than it gets in federal benefits. If CA only paid for what it got, it could instantly erase its state-level budget. CA is getting help when it needs it because it provided what it could, when it could.

        This is the difference between the US and the EU. One, people can move from CA to other areas, if needed. Second, while there may be cultural differences, Iowans are a lot closer to Californians than Germans are to Greeks. Third, it’s not like Iowan bankers were getting fat off loans made to Californians, the way German banks pumped money into periphery states. This actually makes the case that the EU should be MORE likely to bail out periphery states.

  6. HydroCabron

    The facade of the garage and bedroom windows reminds me of Fredo Corleone, with his pencil moustache.

  7. Laura Louzader

    PR, I’m no angrier over paying for CA’s problems than I am about paying Target to build a store 2.3 miles from an existing one for the sake of “economic development” in Uptown Chicago, or $400K a unit for “affordable” subsidized rentals in an area where the city could pick up dozens of perfectly nice and livable condos languishing on the market under $100K in this worst of all condo markets.

    Never mind the multiple bailouts for the auto makers and banks and Donald Trump, or the subidies for casinos, or for NOT GROWING ANYTHING on a 1000 acre spread in Iowa you inherited and never worked an acre of, or for our airlines, or to induce United Airlines to rent all that vacant space in the Sears Tower ($37M), or for faith-based initiatives, or the highway Walmart wants to build a store 80 miles from anywhere, or whatever.

    We have so many people and entities so dependent upon so many subsidies that it has become impossible to tell who pays for what, and what truly pays its own way. I no longer have political axes to grind about this subsidy or that, so much as I would like our economy to be desubsidized as to restore honesty and transparency.

  8. AZDavidPhx

    Crazy gal in New York pays 700.00 a month to live in a virtual < a href=",0,1602721.story">prison cell

    Hilarious and sad at the same time.

    Must be some DAYAM good weather over there!

    1. Laura Louzader

      I saw the 90 sq ft Manhattan apartment. It’s really not that small for NYC, especially for the low rent she’s paying.

      People will do ANYTHING to live in Manhattan. It has always been an ultra-expensive borough, and even the upper west side and lower est side are stratospheric. When I was a young girl contemplating a move to NYC decades ago, young people just out of college would quadruple up on studio apartments that cost more that luxury 2 bed apts in my native St. Louis. If you went away for the weekend, the other girls would rent out your space. Any vacant space qualifies to be made into a living space, because the place is just so crowded and in demand.

      It has always struck me as being faintly insane, but if you are in certain industries, like fashion design, say, or advertising, there’s almost no other place to be.

      San Francisco’s even worse on cost of living, but doesn’t offer the career opportunities.

      1. Misstrial

        Sorry, but with all due respect SF is less expensive relative to real estate than Manhattan, whether Uptown, Mid-town, or Downtown. SF is cheaper by about 50 percent.

        RE: food – there’s always the Farmer’s Market on Wed & Sats at The Ferry.


        1. Laura Louzader

          That’s hard to believe. San Fran is the only city I’ve seen in the U.S. where a fractional share of a moderate sized condo sells for over $200K.

          And how exactly does that work, I wonder? Is it a time-share thing?

          1. Misstrial

            You are getting info from the wrong places.

            I am moving to SF this summer.

            Prices in Pacific Heights are half of what they used to be. I am looking there. Same for the rest of the city.

            A close friend recently bought a luxury 1-BR for $325k in the Financial District towards The Ferry.

            I am aware you are in Chicago. Please do not comment on areas you are not up-to-date on.



  9. BigD

    Wow, looks like the smart, and financially available men are dogging single irvine women who lease their Irvine lifestyles…LOL

    “I am looking for someone who is asian, down to earth, with a warm smile, intelligent, healthy, caring, well educated, and kind, financially responsible (no more HELOC abusers(pretenders who lease everything), who live in Irvine! Geessssh WTF are YOU thinking! Im not looking to bail you out of your debt problems!). Someone who appreciates a man going downtown. Someone who can hold an intelligent/stimulating conversation, and no mental baggage. ”

    HAHHAHAHHAHHAHAH LOL!!!!! TOO FUNNY TO even comment!!!!!!

    But he likes going down… LOL

    1. SanJoseRenter

      Actually the stuff after “financially responsible” is made up by BigD.

      But that photo … cargo shorts and sunglasses is something I’ll have to remember to avoid when I do a personal ad. 🙂

  10. nobody

    uh, no, it has been changed. You’ll notice the person is now shown to be currently online…

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