The Bishop and the Butterfly: Murder, Politics, and the End of the Jazz Age
    Ramona's picture

    Foreclosure for Fun and Profit

    There is a lovely new residential-shopping complex in Myrtle Beach called "The Market Common".  We haven't been there yet this year, but last year we walked around it a few times.  In my wildest dreams I couldn't afford anything in their shops, but honestly?  I never saw anything I would be willing to give up my entire SS check to buy.  Still, I kind of took a liking to the place, faux as it was.

    But this morning I saw an article in the paper titled "Familiar Face buys Market" and was surprised to see that Market Common had been in some trouble last year.  They weren't paying their bills.  Imagine that.  Now bear in mind that I know literally nothing about high finance or luxury real estate or anything, in fact, that has to do with money in the six figures, but something about this story stinks to high heaven.

    Let's see if I got this right:  Company A takes out a construction loan for $105,000,000 in order to build the place, but after a couple of years prices drop and the place isn't worth that much so somebody makes the decision to stop making payments.  The entire complex goes into default and is foreclosed.  Then the parent company of Company A goes to the same bank that brought about the foreclosure and says how about we buy it back from you for. . .oh, I don't know--$19,000,000?

    The bank (JP Morgan-Chase) says okay and everybody, including the Myrtle Beach city manager, is happy.  No pain--much gain.  The Sun-News says, "The owners of the Market Common probably would have been able to continue to make payments on the loan, but chose to default because the property is no longer worth what it would cost to build, said Dan McCaffery, president of McCaffery Interests in May."

    The loan, it turns out, is what's called a "nonrecourse loan", which means that in case of default the bank can't come back and claim either the company's or any company employee's assets. Handy.

    McCaffery said the property's value has dropped, and there were better investments than continuing to pay on the loan, despite nothing being wrong with the project.

    Tom Leath, the MB city manager is thrilled:  "We are pleased that the purchaser is tied to Leucadia [the defaulter] because we think obviously they know exactly what the issue is, and they understand the market having been here a few years.  There is no learning curve with them."

    Leath also told the Sun News that companies throughout the country are choosing to walk away from properties that have substantially lost value and are no longer sound investments, so this situation is not unique.

    "If you look at the foreclosure as a calculated business decision," he said, "then I don't think it's odd that they got back in line to buy it back."

    So. . .you know where I'm going with this, don't you?  Say I'm Joe Blow and I took out a mortgage on a house a few years ago, but now it's worth far less than I still owe on it, and I want to get out from under it but nobody in their right mind is going to pay me what I think they should.  Not in this economy.  I decide I don't want to make payments on a losing investment anymore so I go to my bank and tell them,  "I owe you a whole bunch of money but I don't see any future in paying any more on that losing proposition of a house, so how about this?  We let it go into default, but you hold it for me and I'll pay you about a tenth of what I owed on it before."

    What do you think they would say?  




    The loan, it turns out, is what's called a "nonrecourse loan", which means that in case of default the bank can't come back and claim either the company's or any company employee's assets. Handy.

    The deck is stacked.

    Actually, it gets worse:

    Enter the "short sale"--sort of a variation on the commercial do-si-do that you referenced, only here it's where Joe owes 400k, the property is now worth 250k.  Sam wants to buy (for 250), which  will mean the bank eats 150k, hence "short" sale.

    Bank approves (failing which the sale cannot go forward) because, among other things, foreclosure may mean many months with no cash flow, fees, costs, what have you.

    Joe asks bank "hey, if you'll sell it to Sam for 250, how about selling it to ME for, say, 275.  My kids' don't lose their friends, school, etc., you are 25K better off, etc.

    Bank says, no way, Joe (I'm avoiding the ethnic temptation here...)

    They fear "moral hazard", translation, the guy down the block making the same proposal even tho he actually will pay the full mortgage if no other option offers.

    Just out of curiosity, what if Sam is Joe's parent? Does that change things any? (This is not meant to be snarky in anyway, but is a sincere question wondering how the banks would prevent that particular gaming of the system.)

    I am given to understand that they try to sniff out "straw man" purchasers, which to my mind makes them even bigger stinkers.

    I have to believe that before they will watch the doors and windows chopped out by Visigoth Wrecking and Demolition (see link to Ellen's site) they will soften their stand.

    Of course, the negotiation envisioned has to happen before the title actually leaves the homeowner, and since much of the "vig" that accrues to a foreclosed homeowner consists of rent free occupancy for some indeterminate but usually substantial amount of time following the filing of an action, any actual window/door removal would have to be delicately timed; no one wants to live in a house with big holes in the walls.

     Of course, thus far the Goths have been cheated of their booty by the panic ridden bank caving before the removal occurs.

    There's an interesting story on Ellen Brown's blog (yes, that's our Ellen, with the eye) detailing a business model aimed at leveling the playing field when short sales are ok with the bank but lien reduction is a no-no.

    How do you know for sure that's that's the same Ellen? Just asking because I have long followed her commenting, always found her thought-provoking.

    Check the is like a voiceprint.  Also, there's a picture of her which, if you take thrity years off and enlarge the eye,....

    Check the style

    And the content, btw.  The ideas she advances are the same ones she pushed on tpm.

    incidentally, (and perhaps not surprisingly) she is widely recognized as a prominent "monetary reformer", presently in the forefront of the "state bank" movement.  She is cited by Washington's Blog, who is cited by Naked Capitalism which just came in as first in the top twenty influential enconomist blogs (Krugman was 7th!)

    Now how do you think all those current residents of Myrtle Beach got the money it takes to live there ?

    'nough said.

    Lots of po' folks in Myrtle Beach.  The banks don't like them as much.

    I don't see anything absurd in either the corporate or mortgage borrower scenario.  Now wigh mortgages it's tricky because some states have no recourse mortgages and some have recourse mortgages.  If you have a recourse mortgage, walking away is harder.  Your lender can come after you for the difference.  You pay more for a non-recourse loan because the bank gives up that protection.

    We tend to view debts as a sort of moral obligation and this muddles our thinking.  When we borow $10 from a friend we intend to pay him $10.  It's not about the money, it's about the friendship.  But when you borrow from a bank, it's a business deal.  The bank is taking a risk.  They charge you for that.  Just like when somebody offers to mow your lawn for $10, the bank is saying, "I will take this risk for x% of what you borrow every year until you pay it off."  You are paying the bank to take a risk just like you pay a restaurant for a steak.

    Well, you don't pay if the lawn never gets mowed or the steak never gets delivered, right?  And when you have to, or choose to, default on a loan... guess what?  The bank is doing its job.  It's bearing the risk you paid it to bear.  A smart bank knows that an $80 million loss is better than a $100 million loss.

    We need to encourage more debt negotiation up and down the economy.  That, rather than the  moral temptations of sacrifice and austerity would get us back on track.

    You're right about the moral aspect  We expect we'll pay our debts when we enter into the contract.  But what you're ignoring is what happens when ordinary people default.  They lose their credit rating and from there any chance of low-interest loans or mortgages.  Life is not the same when ordinary people default, as it is when corporations do, apparently.

    Are you saying that banks will enter into a no-recourse loan with an ordinary person of ordinary means?  I highly doubt it.  People are out there begging to renegotiate their mortgages and their pleas fall on deaf ears.  That's what makes this story so damned annoying.

    I'm not sure I agree with your basic premiss, Destor.  In the old days, banks were vigilant about making sure their risk in lending was minimal; job security, income, payment histories, and everything else that you could provide them were absolutely required.  And in the end, if you defaulted, they got a house that was worth the same or more than it was when the loan went through in the first place.  What you were paying for was interest on the loan because without the bank giving you a few hundred thousand dollars, you could not EVER save it up and own a home.  In other words, risk was eliminated as much as possible by careful vetting.

    All that changed when lending "instruments" were used to reel in sub prime borrowers.  Anyone in the industry knew this was coming, but they all hoped to cash out before the floor fell , and many many of them did.  

    I actually DO view debt as a moral obligation, because a debt is something I have promised to pay.  The fact that it is a business deal is irrelevant.  If "business" negates morality, why not just steal what you need from any store you can get away with stealing from?

    So when you say that you agreed to pay the bank for taking a risk, and so walking away is just part of doing business, I have to ask, "Where does it end?"  When I borrow from a bank, I pay them interest for the opportunity to spend money that I don't have.  Smart banks don't lend to people who make $40,000 a year and want to buy a $600,000 house with nothing down.

    I see your point CVille, though I tend to agree with Destor's general perspective on this. Maybe one counterpoint to what you say is that the 'promise' one is making - i.e. the contract one is signing - varies from state to state. In full-recourse states you are promising to pay the money back. Period. And failing to do so is, as you say, both a legal and a moral failing. In non-recourse states you are promising to hand over the money borrowed plus interest OR the underlying asset (the house). So no promise is being broken when one chooses to hand over the house and walk away.

    In normal conditions, and with a normal contract (i.e. those without the interest and principal payments backloaded to the later years), it just won't ever be in a solvent borrower's interest to walk away and hand over the asset rather than pay off what remains of his debt. The question arises when conditions are not normal - i.e. a national drop of 50% in house prices and unemployment at 20%, and banks are failing to do what would be in both their and the borrower's interest - restructure the loan - what is then the 'responsible' thing to do?

    There is one's responsibility to one's family, and to society, as well as to the lender. And the first two considerations will in many cases weigh in favor of walking away. The last consideration - one's obligation to the lender is also not so clearcut when the banks are themselves dysfunctional and not quite blameless in causing the crisis. In my opinion, at least, you can't have a successful economy if the only parties who act in accordance with morality over and above legalities and pragmatics are middle and lower class consumers while the corporates and the rich run riot. To continue to act morally in one's dealings with them even though they do their best on their side to screw you is a form of so-called 'moral hazard'. It just encourages more of the same immoral behavior on their part.

    I find the whole issue of morality and economics incredibly hard. Steve Waldman over at his Interfluidity blog (by the by my favorite econblogger) has recently put up a series of posts on the issue - with a particular focus on the 'ethics of jingle mail' debate. In case you're interested...

    As you say, in a non-recourse state, the bank has implicitely priced the mortgage (going in) with the possibility that they will be left only with the asset, and not the full value of the loan indemnified by the full measure of the borrower's assets.

    The recourse state loan, per contra, leaves the lender with the opportunity to levy on the borrower's assets or income to satisfy a deficiency judgment.

    In such case, we have, as a society, made a policy decision that such judgments (absent fraud in the inducement to lend, a not insignificant contingency vis a vis current mortgages) are subject to discharge in bankruptcy.

    Query: Does this not fully exhaust the moral issues involved in jingle mail?  The alternative mandate (to, for instance, forego directing cash flow to your kid's school tuition, enroll her in the crappy public school down the street, so you can continue servicing the mortgage on your now deep underwater property) may allow you to maintain your good credit, but is there a moral imperative to do so?

     The penalties for non payment are clear.  The reasons to discontinue paying likewise.

    The counterparty, after all, is not the little old lady down the street who has deposited her tiny nest egg with the bank and who is thus at risk by your default.  That risk has been socialized by the FDIC, and all our taxes pay for the deep pocket into which the bank will reach.


    Obey, I'm glad you responded because I didn't realize it sounded like I think that walking away from a loan that you can't pay is a moral lapse. I really do believe that when you promise to pay, then, backing out AS A BUSINESS STATEGY is the wrong thing to do I was ithinkng back to the original example of a calculated scheme of walking away and cashing in on firesale pricing.

    The banks who targetted those who clearly could not pay their mortgages are the ones who created this mess, and they did it knowingly and with the idea of making tons of money and then passing off the risk to some-anyone else. They are the thugs in this scenario, and I agree that restructuring the loan is not only the right thing to do, it is also better for the economy. Multiple foreclosures ruin the real estate market and contribute to the idea that times are bad

    Again, thanks for your comments. I think we pretty much agree on the big picture.

    As Senator Kaufmann warned us recently, no one knows how many of the mortgages in relatively recent history are based on fraud, but he and his committee expected a lot are, and this administration's DOJ seems not to have the stomach for invvestigating and prosecuting the banks, but seem to prefer to cover the issue up, and hope for the best.  (Not a good idea.)

    Many leading economists say that there will be no economic recovery until public confidence is restored by prosecuting fraud, and getting the big banks books balanced, even if it means they take a bath.  Disturbingly, the administration's good friends at Third Way (fresh thinking, or whatever) have put out a report that sounds great unless you dig deeper than the cover sheet.  Emptywheel at FDL and Yves Smith at Naked Capitalism are furious at the potential perfidy and immorality; their plan, among other things, would preclude mortgage holders from suing banks.

    That's just wrong, as is many points of their 'solution'.  Morality should not just be the duty of the borrowers.

    If "business" negates morality, why not just steal what you need from any store you can get away with stealing from? mean like Wall Street investment bankers ?

    "Moral" and "wall street" don't belong in the same sentence!

    I have promised to pay.

    Credit ratings, as you probly know, are a combination of

    ability to pay

    willingness to pay.

    In the case of the walkaway from an underwater mortgage, we are obviously assuming ability bo pay (since otherwise there is no moral dilemma-blood from a stone, and all that)

    You, clearly, are a better credit risk than, say, for instance, me.

    If I find myself bound to a contract where the basic assumptions underlying the meeting of minds that occurred five years ago have soured, I'm not going to sacrifice my family's well being so that a bankster can drive a Lamborghini.

    Call me a Bolshevik if you wish, I take it as a compliment.

    But it isn't fair to use the analogy of stealing from a one is proposing anything illegal.

    (By the way, I think you could, if you wanted, jack the house up and roll it away as long as the foreclosure sale had not yet occurred.  Of course, you'd need a place to put it and a hell  of a big flat bed truck.)

    Or, you could just take the copper, the furnace, the windows, doors, flooring, and anything else of value.

    That's the law.

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