Monday, January 25, 2010

Underwater, but Will They Leave the Pool? NY Times

http://www.nytimes.com/2010/01/24/business/economy/24view.html

Economic View
Underwater, but Will They Leave the Pool?
By RICHARD H. THALER
Published: January 24, 2010
Even if they owe more on their mortgages than their homes are worth, many people feel obligated to repay their loans. But what if those borrowers walked away?

6 comments:

JimTan said...

The guys still paying their mortgages are ones who won't walk away. They will pay as long as they have jobs.

Let's cheer for the economic recovery!

david said...

I am not surprised that people underwater arent walking. It is a pretty big sacrafice to walk. It hurts your credit and I think you cant own again for 5 years (well at least you cant get a mortgage).

Unless you are under by at least 50K, give or take depending on the place and your income, i really dont think it is worth it to walk.

After all most of these people bought more to live in and less as an investment. I would be most people who walked so far either didnt have a choice or were speculators.

patriotz said...

The issue is not really whether the property is underwater - which is a balance sheet issue, and an illiquid one - but about cash flow.

An owner whose monthly payments are comparable to renting is not going to care much about the balance sheet. Why should they? As long as they stay in the house it means nothing.

Crunch time comes when an owner with a serious cash flow deficiency becomes unable (job loss) or unwilling to pay. That's when people start walking.

We saw a lot of it in 1982 and we will see it again. Lender recourse against other assets doesn't matter much - if you can't pay, you can't pay.

alexcanuck said...

Correct as usual, Patriotz, but you don't go quite far enough. What you describe (underwater, but rent-equivalent payments) is an inherently unstable situation. If an investor can swoop in and snap up lower-priced properties and put them on the rental market at a lower rent, the payment is no longer rent-comparable. Alternatively, the owner can walk, buy a new, lower priced home and have lower payments.
Recognizing of course that the credit impairment caused by default will interfere somewhat, but I think it's still a valid point.

patriotz said...

If an investor can swoop in and snap up lower-priced properties and put them on the rental market at a lower rent

Falling rents aren't a result of falling prices. Landlords rent properties out for whatever they can get, which is completely unrelated to what they can buy properties for.

Falling rents are the result of oversupply, which is the result of excess prices. What better example than right now in Vancouver when nominal rents in the condo market have fallen at the same time as prices have risen.

Asset bubbles ultimately result in lower rents. That's why long distance calls are so cheap now - companies like 360 Networks grossly overbuilt capacity.

Rents didn't go down during the early 80's bust in Vancouver. The previous bubble was too short to result in significant oversupply. Also there had been a prior shortage of rentals due to strict rent controls.

But the "underwater property, cash flow neutral" scenario is pretty hypothetical, since the very reason we have RE price busts is that the cost of buying has exceeded renting. The only real exeception was the 1930's.

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