I am an optimist by nature, but believe strongly that the U.S. economy will take a significant nosedive beginning in June 2010 and get worse through October 2010 as well as throughout 2011 and 2012.
One of the primary impacts of any further deterioration of the economy is that literally millions of people cannot afford their current mortgages. Estimates are that millions of families (already 1 in 6 by late 2008) are underwater on what they owe — they can make the payments but their homes are worth far less than what the mortgage is for.
It may well be in the economic self-interests of these individuals to just walk away: abandon their homes, take a hit to their credit, and move on. This would be what economists call a ‘strategic default’.
In some states people can legally do this with minimal impact to their economic health because one of the things they bought with their mortgage was the equivalent of ‘underwater insurance’, aka a ‘non-recourse loan’.
If your mortgage is a ‘nonrecourse loan’ then you probably paid about $800 per $100K of value when you closed your mortgage financing. In a non-recourse loan a lender legally has ONLY your property as security for their loan; they cannot go after your other assets.
Why People Should Think About Their Options
University of Chicago professors Eric Posner, a law professor, and Luigi Zingales, an economist, see rough times ahead and have a suggestion as to how both individuals and our banking system can make it through these rough times.
These guys are not from the liberal side of thought. They firmly believe in taking responsibility. So when something like their proposal hits the street then I recommend listening.
Both are from the University of Chicago, and Luigi Zingales is from its Chicago School of Economics — considered one of the world’s best economics departments with more Nobel Prize winners in economics than any other university.
The Posner-Zingales Proposal as described in the New York Times: “Any homeowner whose mortgage is underwater and who lives in a ZIP code where home prices have fallen at least 20 percent should be eligible for a loan modification. The bank would be required to reduce the mortgage by the average price reduction of homes in the neighborhood. In return, it (the bank) would get 50 percent of the average gain in neighborhood prices — if there is one — when the house is eventually sold.”
The Posner-Zingales Proposal is a free market approach that is in the best interests of both the banks and individuals — if you take the long view and do not just focus on quarterly profits.
It is doubtful however that banks will embrace this idea.
Be warned: late 2010 will not be kind. It will be in the self-interest of millions of American families to shed debt and to avoid new debt, however they can. The banks write it off and get bailouts. Your options?
Notes:
- Non-Recourse Loans Explained: http://www.allrmc.com/articles/Non-Recourse_Explained_.php
- University of Chicago Department of Economics, AKA the Chicago School of Economics: http://economics.uchicago.edu/
- Richard H. Thaler, Underwater, but Will They Leave the Pool?, New York Times of January 23, 2010.
- Luigi Zingales and Fierce Finance Winners & Losers: http://www.fiercefinance.com/tags/luigi-zingales
- Eric Posner bio, University of Chicago: http://www.law.uchicago.edu/faculty/posner-e
- James R. Hagerty and Ruth Simon, Housing Pain Gauge: Nearly 1 in 6 Owners ‘Under Water, Wall Street Journal, October 8, 2008.
