Strategic Defaults

Housing recovery threatened by 'strategic defaults'
Bankers: Credit will tighten as people bail on mortgages

by Catherine Reagor - May. 23, 2010 12:00 AM The Arizona Republic

Homeowners walking away from mortgages because they owe more than their homes are worth will make it more difficult for all borrowers to obtain loans. And a tougher lending climate could stifle sales and delay recovery of the battered Phoenix-area housing market.

That's just one take on the worst Phoenix housing market in history from a group of Arizona banking leaders approached by The Republic for a discussion on the market.

Five current and former banking executives were asked a series of questions on the causes behind the housing crash, prospects for a recovery, the notion of walking away from underwater mortgages and buying a house as a longtime home vs. a short-term investment.

Lenders have taken the brunt of the blame for most of the housing crisis and have been criticized on their efforts to work with homeowners facing foreclosure. Through a series of phone interviews and e-mail exchanges, this was their chance to respond and share their point of view on the housing market.

There is also concern that many homebuyers still see homes as speculative investments and not long-term places to live and invest in. The speculative mentality among Phoenix-area homebuyers led to the 2004-06 boom and contributed to the painful bust. Now, about 40 percent of all Phoenix-area homeowners are underwater. During the past year, more than 60,000 homes in the region have been foreclosed on.

Walking away
People abandoning houses and mortgages they can afford - or walking away, as it is now commonly known as - has become a polarizing issue between homeowners and lenders.
Thousands of Phoenix-area homeowners owe more than their houses are worth and don't want to wait as long as five to 10 years for home values to rebound. Others have unsuccessfully tried to work out loan modifications with their lender. Some believe it's a smart business decision to stop paying on an asset they can't sell for its current value. So a growing number of homeowners are considering walking away or have already done so, committing what has become known as a "strategic default."

Lenders see walking away as a broken contract. They are also concerned if enough homeowners walk away from mortgages, future mortgages will be harder to obtain for everyone as the market adjusts for added risk.

"When individuals walk away from a mortgage, there is a ripple effect that goes far beyond the immediate problem," said Bill Randall, a Phoenix resident and former president of First Interstate Bancorp. "It is likely banks and mortgage lenders will tighten credit standards."
Timothy Disbrow, manager of Wells Fargo Home Mortgage Arizona, said it's never a good idea for borrowers to miss one payment, let alone walk away if they have the ability to pay.

"Strategic defaulters hurt us all. We simply have to be able to trust that when a borrower signs their name, they will honor their commitment," said Candace Wiest, president of Avondale-based West Valley National Bank. "Massive strategic defaults will result in less credit availability. Everyone loses in that scenario."

Amy Swaney, a past president of the Arizona Mortgage Lenders Association, said "a significant number of homeowners walking away will slow the recovery."

Speculating on homes
Part of what drove the housing market down, the lenders said, was an inordinate amount of speculation on houses and irrational expectations about home values.

The speculative mindset among metro Phoenix homeowners must change, they say, to ensure a long-term recovery of the housing market.

There's been a dominant shift from long-term to short-term motivations among metro Phoenix homebuyers during the past decade. Because of the region's reliable increases in home value, people began to count on houses for quick profits.

Swaney said all Phoenix homebuyers were speculators during the boom, even if they didn't realize it.

"As home prices continued to go up, and more people had access to equity in their homes, the pool of buyers continued to grow," she said. "The loans were easy. People didn't think they were doing anything wrong as long as the market kept going up. In 2007, the declining housing market uncovered a massive web of inexperienced speculation."

Swaney said the market can't repeat that cycle or the economy won't fully recover.
Wiest said the housing-speculation problem extended into all levels of the Phoenix housing market.

"A local hairdresser in her 30s told me she owned four homes," Wiest said. "I went home and told my husband either she was an exceptional hairdresser or I was an underachiever bank president because I had no idea how she could afford four homes."

Lenders say the majority of homebuyers cannot continue to think of homes as speculative investments that yield quick returns. The quick-flip mentality that led to Phoenix's boom and bust will push back any permanent rebound in home values.

"Trading houses or viewing them as a short-term investment involves risks that may far exceed the individual ability to deal with them," Randall said. "The financial obligation (of buying a home) is usually very large in relation to the individual's net worth. The (housing and mortgage) markets are volatile. It is not appropriate to think of a home in the same way you would trade stocks."