Well not the current house we live in, but the previous home we owned. I’m actually quite bummed out about this news. We had a lot of great memories in that place, and I am sad to see anyone experience misfortune. But is it really misfortune, or moral hazard?
After we got married, we decided we needed to move closer to New York City. It would be closer to work and closer to most of our family. My wife works in Nassau county, and her commute was a killer. Some days it would take 1 1/2 hours. In just 4 years, her car had almost 100,000 miles on it. One snow day it took her over 3 hours to get home. That was the last straw that broke the camel’s back.
So in late 2004 we decided to start looking for a new home. The requirement was it had to be in Nassau County, close to her work, and a moderately priced house. For those not familiar with how expensive Long Island can be, it’s not uncommon for a “modest” house to go over $400,000 even in today’s market. Taxes are also outrageous, but that’s a story for another time.
We found a house we wanted and decided to sell her house ourselves. If you remember early 2005, the real estate market was on fire. We figured we could easily sell the house ourselves, and we were right. After our initial open house we immediately got three offers. We determined a mother and daughter offered the best terms. They owned no existing home, so it was quicker for us to get into our new home. The other buyers had existing properties they had to sell first.
The Buyer’s Terms
This is where the story gets interesting. After we accepted their offer, we soon got a call asking if we could increase the price so they could get cash out at closing. Our basement wasn’t finished. They wanted to use the money to complete it and pay off some other bills. We initially were a little hesitant, but accepted the new terms after consulting our lawyer.
Then my wife went to closing and found out the terms of their mortgage with the bank. My wife had to sit through a long signing process by the mother and daughter. It turns out they took out two mortgages, one was fixed, and the a other balloon payment at some determined date. When my wife came home and told me this, I knew this wasn’t a good sign for them. They not only took money out at closing, but also had two mortgages. If I remember correctly, it came to 110% of the value of the home. All of it was a no money down deal. What was not to like for them? They were in a house with nothing down.
The Oh No Phone Call
Fast forward to 2012. Two weeks ago I got a phone call from a collection agency asking if the number they called was still associated with our old address. When we moved, we kept our old number by using VOIP. We frequently get telemarketing calls thinking we still live at the old address. I assume this collection agency used a reverse lookup directory and found our number. They asked by name for the mother and daughter who we sold the house to. I pretended to not know anything and hoped they would no longer call us.
After I hung up the phone, it got me wondering if their house was for sale. Sure enough, after looking on the Interwebs the house is on the market, and it’s a short sale. In simple terms, this means they probably haven’t paid their mortgage in months, and more than likely years. It’s now a matter of time before the house is foreclosed on.
Who’s Responsible For This Foreclsoure?
Now this leads me to the question about the mother and daughter and their financial responsibility. I don’t know their financial situation directly. I don’t know if they lost their jobs, or experienced a medical condition. Historically these are both common reasons for financial hardship. I suspect, after first speaking with them, they were barely able to afford the home to begin with. In normal economic times, they probably wouldn’t qualify for a mortgage.
In a microcosm, who’s responsible for this foreclosure? Is it:
- The mortgage broker for getting them qualified for the two loans?
- Us accepting their terms?
- Buyers own fault for getting a home at any cost?
- Wall Street for creating complex financial instruments, by repacking asset backed securities?
At least in this specific case, and in most cases, I would have to fault the buyers. They were the ones actively pursuing buying a house. No one forced them to sign a paper, and buy the house. Just because you qualify for something doesn’t mean you should do it. There is fiduciary responsibility on their part.
It seems like in today’s social environment we really like to put blame on others. At least in my opinion, that’s a sign of weakness, not strength. You can’t control real estate markets, government incentives, or “evil bankers” for giving you a loan. You can only control your actions, and no one else. Nobody cares more about your money than you. This certainly applies to signing a mortgage with your name on it. You could say in some respects they were duped in getting the loan. In someways that might be true, but anyone with simple math skills would realize the terms of this loan were insane.
I’m familiar with the backlog of shadow inventory of foreclosures in New York. It’s possible to live mortgage and tax free, for three years. They bought the home from us for $380,000. It’s currently being sold as a short sale for $249,999.
The owners have absolutely no skin in the game, and logically it makes sense for them to strategically default. No way could they ever recoup the decrease in value, than the time the ding on their credit would last. In theory they could be socking away a lot of money per month not paying. I’m assuming they are able to still pay the mortgage. I don’t know specifically, but they could be playing out this possible scenario. This is especially true, if a balloon payment is coming due soon. While I feel sorry for their situation, I don’t have any remorse if this is the path they have chosen. If it is true financial hardship, the home ownership only sped up the process.
You might say, “OK the mother and daughter you mention were perhaps financially uneducated”. Maybe so, but it still doesn’t make it right no less. Without financial consequences, moral hazard will exist. The next example I discuss shows just this.
New York Times Economics Writer Not A Financial Genius
Let’s use an example of some who should have known better, but didn’t. New York Times economic writer Edmund L. Andrews wrote a book about his experience called “Busted: Life Inside the Great Mortgage Meltdown“. He presented himself as the common man who was bamboozled, by the banks, mortgage brokers, the Federal Reserve, and wait for it… the Bush administration. When Edmund does blame himself, he goes off in detail why it’s still not completely his fault.
While I haven’t read his book, I read a number of reviews on Amazon and detailed reviews on the web. I also read the New York Times article article he wrote. This quote in the article sums up the guy’s stupidity:
The only problem was money. Having separated from my wife of 21 years, who had physical custody of our sons, I was handing over $4,000 a month in alimony and child-support payments. That left me with take-home pay of $2,777, barely enough to make ends meet in a one-bedroom rental apartment. Patty had yet to even look for a job. At any other time in history, the idea of someone like me borrowing more than $400,000 would have seemed insane.
Too Many Financial Mistakes
For a normal person with common sense and an economic background, all sorts of warning bells should have gone off. Instead he kept pursuing, in his words his “insane” goals. How is the fault of other parties he puts blame on? The fact of the matter, he was hoping to beat the system, and lost big time.
After reading his article and finding more backstory of Mr. Andrews, I have absolutely no sympathy for the guy. Every step of the way he made many financial mistakes. After all he wrote about the very stuff he was doing in the New York Times. You would think a guy who writes about the economy would know better right? Instead he followed his heart, and not his head, many times throughout his saga.
The story gets even better though. In his book he fails to mention his new wife’s serial bankruptcies. One before his marriage, and one during his marriage soon after term limits of the first bankruptcy expired. How is that not a critical part of the story? It shows no concern of debt obligations and lack of financial responsibility. Instead he paints a much subdued story if this could happen to him, it could happen to anyone. His story reeks of elitism and entitlement to things he never deserved in the first place.
Mr. Andrews fully knew he could barely afford the mortgage. He also knew his new wife was a homemaker who hadn’t worked in twenty years. Somehow she was going to make up the $60,000 diference to cover other expenditures with a new found job. The story gets worse. I discovered he didn’t use the book deal down payment he received to pay down his mortgage. Instead he was trying to force his bank to lower his loan principal.
This isn’t to say that others weren’t involved in the mortgage crisis. As he details in his book, there are certainly many people to blame along the way. But for a well educated writer, who should have known better, he made many personal and financial missteps. In a display of moral character, Ed Andrews was also fired from his job at the National Journal, for inappropriate behavior.
When one cannot manage their own personal finances, I for one do not take their economic advice seriously. This is akin to listening to a doctor’s advice to stop smoking when they themselves smoke.
Readers: Now that we have some perspective, what do you think about the financial crisis? Do you think the ones who took out a loan should be responsible for their own actions? Otherwise how do we prevent moral hazard?
I believe everyone is responsible for their decisions. The mother and daughter show have known it was a risky investment when you have no equity. There is another culprit in this deal that is equally responsible, the bank. Why would they loan 110% of value to them? This is true for the financial crisis the borrower and the bank approving the loan are responsible.
Hi Krantcents:
Then normally it forecloses on the home. Banks do not want a foreclosed property and would rather the owner keep paying. They obviously lose out if a property sits idle and no mortgage money coming in. They would also rather deal in a short sale as a last resort.
If I were a bank, yes I agree it’s stupid loan and would never agreed to such a deal. Though who are we to say they shouldn’t give out the loan? It’s their business and their risk. Forget for a moment this time period and the government incentives to do these types of loans. Forget also the massive bailouts to huge bank conglomerates. As these are completely different discussions than this specific topic.
The details we don’t have is at what APR? This is no different than my Lending Club loans. There are definitely some loans I pass on. For example, I won’t touch small business loans (sorry fellow business owners). Same goes for student loans. Both historically have huge default rates and Lending Club’s stats show this.
Both borrowers mentioned in my article without question would be categorized as subprime. There was a point in our history you wouldn’t even qualify for a loan. To me I think lenders should be allowed to target that audience if they want, they then should be allowed to charge the appropriate fees to ensure profit. Otherwise the government should not put into place mandates to require banks to service that audience. The higher rates for some individuals would dissuade them from accepting the terms (ie a 12% mortgage rate)
You might say, “OK the mother and daughter you mention were perhaps financially uneducated”. Maybe so, but it still doesn’t make it right no less. Without financial consequences, moral hazard will exist.
Where’s the moral hazard with the mother and daughter? Their credit will take a hit and the bank will reclaim the property, which I’m sure are the consequences laid out in the terms of the original mortgage. Where’s the moral hazard when the contractual agreement that established the transaction is still fully enforceable at the banks discretion?
The reason banks don’t act on filing notice of defaults, allowing non-payers to continue to live in the home, is because FASB 157 doesn’t force them to take an impairment until the NOD is filed. So they opt to delay executing their contractual rights, in order to avoid a mark to market blood bath. That seems more like moral hazard (not having to mark to market sooner) for the banks tricking down to some non-paying mortgagees than moral hazard outright for the “home owners”.
The bank took a risk, that house prices would stop rising or fall, and lent to people who had negative equity on day one. Now the bank and the occupants (never to be confused with owners) are reaping what the sew, just slower than you’d expect due to lax accounting standards.
I guess comments aren’t HTML tagable, the first paragraph of my comment above is a quote from the post.
I guess what I’m saying is the moral hazard is there were able to get a loan to begin with. Which then caused a cascading effect.
There’s fault everywhere except fo you guys. I don’t think you were at fault for selling.
The buyers were at fault for going into a mortgage they had no reason getting. I think it’s pretty common to know you need a down payment for a home. If you are borrowing 110% then something is fishy. Hell, even with 20% down a home payment can be tough, what with taxes and all sorts of other expenses that creep up.
No one needs to buy a home. You can rent or even buy a co-op or condo until you are ready for a home.
But the banks are at fault too. They made such a loan available. Today you couldn’t even think of getting a loan like that as it’s so ridiculous.
I think the crisis is still the result of the bank’s greed over people though. There’s enough cases of loans that weren’t even checked for income.
It almost sounds criminal that you could buy a home under that kind of loan.
@glen: Aren’t the buyers considered greedy in this case also? Why single out the banks?
I think the buyer is responsible, but this is an interesting twist on foreclosure, in that you have a direct role. If there was a movie about it, you would be in it!
That’s an unfortunate story. However, the buyer is at fault for taking on a loan that they could not afford. The bank is equally to blame for loaning them the money. Everyone got greedy and both had to pay the price. Do you as a seller have a share to the fault? That’s a good question.
Not surprisingly, the only person I blame is the buyer. You are guys are in the clear because you were serving yourselves; the broker is in the clear because they were acting pursuant to their directions of their client; the bank is in the clear because they had no responsibilities to anyone but their shareholders (which they arguably failed lol)….leaves us with the buyers!