Morgan Stanley: Strategic Defaults Reach 12%

[Joanne98]

Bloomberg provides a summary of a report by Morgan Stanley that has tried to quantify the level of strategic defaults. The analysis seeks to identify borrowers who walk away from mortgages that they can arguably afford, and defines that group as those who go from paying on time to missing three mortgage payments in a row, while still paying on time on other consumer debts that are greater than $10,000.

This definition highlights some interesting issues. First, it’s a reminder of how pervasive consumer indebtedness is in America. In the 1980s, it would be almost unheard of to get a car loan or run a credit card balance. Second, it also suggests that some of these strategic defaulters are simply “pre defaulting”, as in recognizing their ability to service the mortgage is tenuous (as in they may be straining to stay current, and recognize that one shock will put them in arrears) and they’ve decided, with the home under water, that it’s better to face the inevitable early. Third, and perhaps most important, the defaults again illustrate the perverse side effects of securitization. In the old world of a mere 20 years ago, most banks would work with a borrower that was facing financial stress and needed a mortgage mod. The lender would recognize that as long as a mod left it with appreciably lower losses than getting the house back, principal reduction was a sound move. And as we’ve argued repeatedly, deep principal mods have been shown to produce lower redefault rates than payment modification programs.

The report contained other findings:

A fifth of U.S. homes carrying mortgages were worth less than their loans in the fourth quarter, according to Seattle- based Zillow.com, which runs a real estate data Web site. Home prices in 20 metropolitan areas tumbled 33 percent from July 2006 through April 2009, then rose for five months before falling for the next five, leaving them up 2.8 percent from lows, according to an S&P/Case-Shiller index….

For mortgage-bond investors, the data signals a problem with prime-jumbo debt and strengthens the case for investing in subprime, the analysts wrote. That’s in part because strategic defaults are less prevalent among borrowers with subprime characteristics and they may benefit from government-aid programs that don’t target large loans, the analysts wrote.

Yves again. This indirectly raises an issue that Tanta wrote about, that many subprime borrowers did not initially borrow as subprime, but as their financial condition deteriorated, refied into subprime.

http://www.nakedcapitalism.com/2010/04/morgan-stanley-strategic-defaults-reach-12.html