Everyone walking away from their homes is also hoping to walk away from their debts. Will our system let them slide? Should it?

Asking Price: $850,000

Address: 5 Hawk Irvine, CA 92618

Could you whisper in my ear
The things you wanna feel
I’ll give you anything
To feel it comin’

Yeah we’re gonna let it, slide

Slide — Goo Goo Dolls

Back in February of this year, I wrote a post titled The Financial Implications of Short-Sales and Foreclosures. It links to a post written by an attorney on what happens to those who cannot or will not sustain their mortgage payments. To paraphrase the attorney, when people are in these circumstances, they break down into one of four groups:

1. Those who still owe the bank much money;
2. Those who have a big income tax bill with no cash to pay it;
3. Those who owe the bank much money and have a big tax bill
4. Those who owe the bank nothing and who do not have a tax bill.

Everyone wants to be the last case. Many end up as the third case.

Very few research the implications in advance. Since most people do not have any other options, it really does not matter because it does nothing to change their decision.

Even fewer take any initiative to do the right thing. Legally, it is the duty of the debtor and taxpayer to determine if they have any liability and pay it. Realistically, everyone will “keep their head down” and hope they do not get any letters from the bank or the IRS. No letter, no liability. The amount of tax cheating is enormous.

Most of the properties I profile would be the third case from above that owe the bank and the IRS because they were recourse loan refinances, and many were not primary residences. How many people do you think are going to pay either the bank or the IRS? Not many, IMO.

I know one person who walked away from a 100% financing deal on an investment property in Corona. His tax advisor told him not to pay taxes on the shortfall because he listed it as him primary residence on the loan application. That is one hard-working lie. He used it to qualify for an interest rate he did not deserve (owner-occupied housing gets a better rate), and he is using the same lie to dodge a tax bill. He isn’t the only one.

The lenders are finally wising up to the changing situation. Since most people believe they can walk away from their debts in a short sale, lenders are sneaking language into short sale agreements where the borrower is liable to repay the shortfall. Collection of these debts will be a booming business in the coming years.

So what do we do about this problem as a society? If we hold all these debtors liable to the banks and to the IRS, we keep them in a financial hole for a very long time, or we force them into bankruptcy. The societal effect will be diminished economic growth because so much disposable income will be diverted from consumer spending to debt service. However, if we just let these people slide, the moral hazard will be huge. If people see no consequences come from this behavior, they will repeat it. The societal effect will be endless Ponzi Schemes and periodic economic near-depressions as the financing collapses.

No matter what we do, the winners and losers will be determined by caprice. Those who owe either the lender or the IRS and get away without paying will be unjustly rewarded. Those who do the right thing will be punished. There will be no pattern of reward or punishment for behavior good or bad. It is a dysfunctional system, and nobody knows how to fix it.

What is your solution? Let ’em slide? Crush ’em with debt?

Asking Price: $850,000

Income Requirement: $212,500

Downpayment Needed: $170,000

Purchase Price: $404,000

Purchase Date: 12/14/1999

Address: 5 Hawk Irvine, CA 92618

Multiple exclamation points, ALL CAPS, HURRY — all standard realtorspeak is present.

• This property was purchased on 12/14/1999 for $404,000. The owners used a $322,850 first mortgage, a $80,700 second mortgage, and a $450 downpayment.
• On 7/3/2001 they refinanced the second mortgage for $170,000.
• On 9/14/2004 they opened a $280,000 HELOC.
• Total property debt is $772,580 assuming they maxed out the HELOC.
• Total mortgage equity withdrawal is $369,030 including their $450 downpayment.

If this property sells for its current asking price, the lender will recoup all of their money and make $26,420 after a 6% commission. I don’t think anyone believes that is going to happen. Check out the listing price history:

They listed this property for $580,000, then changed their mind and listed it for $850,000. Perhaps this was a transposition error, or perhaps it was a Freudian Slip where the lender put down what the property is really worth…

Do housing market prices in California swing like a pendulum? It appears that way, but the forces behind the movements are entirely caused by people rather than forces of nature.

Asking Price: $492,000

Address: 4 Pendelton, Irvine, CA 92620

Granite — Pendulum

Just leave this place behind,
Ill grill your place, don’t mind.

The cool we know will rise under, they are the future.
Future!

Today’s featured song is from the many readers of the IHB to the overextended homedebtors everywhere. The people who have too much debt should do themselves a favor and just leave their properties behind. No government program is going to save them, and they are just stressing themselves out waiting for a bailout that is not coming. The cool people we know who read the IHB will rise up and buy they properties for under their current fantasy prices. The readers of the IHB are the future. Future!

I was party to a recent open discussion on the housing market, and I am always struck by the idea that housing market prices cycle like the phases of the moon. Cycles of nature obey laws of physics and are not impacted by the activities of man. Economic cycles–like prices in real estate markets–are solely determined by the activities of man and do not obey any laws whatsoever. This distinction is critical because people act as if the real estate cycle is something beyond control; it isn’t. No individual can control the market, we can only react to it, but collectively with changes in incentives and education, we could change the behavior of individuals and make real estate markets considerably less volatile. The pendulum does not need to swing so violently.

As many of you have probably noted, I am an idealist at heart. I would like to see buyer’s behavior change, I would like to see the real estate sales industry change, I would like to see the lending industry change, and I would like to see all the players who inflated the housing bubble be held responsible; this probably is not going to happen. Perhaps a decade from now when we have completed our final wave of foreclosures, the pendulum might swing the other way, and we might inflate another housing bubble. People will forget the folly of The Great Housing Bubble, just like they forgot the bubble from the late 80s, and they will convince themselves “it is different this time”; it won’t be.

Asking Price: $492,000

Income Requirement: $123,000

Downpayment Needed: $98,400

Monthly Equity Burn: $4,100

Purchase Price: $375,000

Purchase Date: 9/11/2003

Address: 4 Pendelton, Irvine, CA 92620

• This property was purchased on 9/11/2003 for $375,000. The owners used a $255,000 first mortgage and a $120,000 downpayment.
• On 5/25/2004 they opened a HELOC for $100,000.
• On 5/10/2005 they refinanced with a $349,000 first mortgage.
• On 8/26/2005 they opened a HELOC for $100,000.
• On 12/15/2005 they refinanced with a $488,000 Option ARM with a 1.25% teaser rate.
• On 6/26/2006 they opened a HELOC for $75,000.
• Total property debt was 563,000 plus negative amortization.
• Total mortgage equity withdrawal was $308,000 including their downpayment.

Indymac The FDIC bought the place at auction on 3/20/2009 for $459,233.

Foreclosure Record
Recording Date: 11/12/2008
Document Type: Notice of Sale (aka Notice of Trustee’s Sale)
Document #: 2008000529916

Foreclosure Record
Recording Date: 07/18/2008
Document Type: Notice of Default
Document #: 2008000345071

Foreclosure Record
Recording Date: 07/10/2008
Document Type: Notice of Default
Document #: 2008000330939

If this property sells for its current asking price, and if a 6% commission is paid, the US taxpayer through the FDIC will lose $100,520 plus negative amortization, lost payments and other fees.

{book3}

Just leave this place behind,
Ill grill your place, don’t mind.
And you’re the only one, ‘cos you’re up on defense.
This is a new way!

We would have reckon now, what we have done, left in the open.
The cool we know will rise under, they are the future.
Future!

Granite — Pendulum