I don't know if this belongs in Political, but I'm pretty sure it isn't a "general forum" type of discussion.

We all know that the country--maybe even the world--is facing a long recession, maybe even a depression. The situation isn't unprecedented. It happened in the years between 1929 and WWII. Japan is only now coming out of deep economic problems dating back to the 1990's. The economic engine has slowed and will be difficult to re-start. Recovery must begin with increased spending by the consumer and the government will try many kinds of things to stimulate such spending--tax cuts, government-funded plans to increase employment, management of interest rates to very low levels, etc. All techniques that have been used before.

In the case of the current U.S. economic problems, the heart of the problem seems to be extraordinarily high levels of personal debt and a dramatic and sudden decline in the values of housing, reduced demand for housing, dramatically increased levels of mortgage loan defaults and foreclosures. We're experiencing a cycle that has almost stopped banks from lending and borrowers from being able to borrow. That cycle has spread to other capital goods industries--autos, large appliances, electronics, even items for major household rehab projects. Such decreased demand has exacerbated the economic decline with increased unemployment, reduced income, etc.

So now to my theoretical question. I'm hopeful that it's not a real situation that any of us would experience personally.

Let's say that you found that the value of your house or condo was substantially less than the amount of the mortgage loan you had taken out. Say the value of your house has declined to only 80% of the amount of the balance on your mortgage loan. Let's say that it's clear that the value of your house will not increase to equal the amount of your mortgage loan for, say another five years or so. As the result you know that you can't sell your house for an amount that would pay off the mortgage for that time. In the meantime your credit rating is suffering because of problems with your job. Your credit rating hasn't been a big consideration because the banks or credit card companies won't increase your credit anyway.

If you found yourself in that situation--would you continue to do all that you could to keep making your mortgage payments on time? Or would you simply stop making mortgage payments and live in the house until the lender foreclosed and forced you to move, simply using the amount that you were "saving" by not making motgage payments by spending it on living expenses, a flat-screen TV or a new car? I'm not talking about a personal bankruptcy. My question has to do with simply not continuing to make payments on a loan, the balance of which has become a lot more than the value of the house used as collateral for the loan.

Unfortunately, the situation I've described is a pretty real one for lots and lots of people. The way they answer the question I've posed will go a long way towards determining how long the recession we're all facing will last. What would you do?

Interesting, but go further. What about the programs they offer for first time buyers and so on. If you dont want to work or do just enought to get by, then you can get up to 40,000 for you down payment. Now the people that are working but dont make what most would call a whole lot can not get this assistance. Now the market is down. who is better off. The person that is trying is in the hole and the one with the assistance it better off and keeping the house. just had a friend do this. got 40 grand for down payment and was told not to worry about any foreclosure, this is a Gov Deal.

And you are definitely right. In today's economy, and especially with all of the perceived campaign promises and the bank bailout misinformation, we are in for 'interesting times."

Kahuna, based on your background, can you please confirm something - As far as I remember home mortgage contracts, if you default and the bank seizes the property and subsequently resells it (straight sale or auction), if the sale proceeds do not cover the note, the bank still can seek recovery of the delta from the individual. Is that your understanding as well?

stop making payments with no intent on leaving the home....knowing banks are refraining from foreclosing on mortgages that are upside down....and wait for a bail out....hand out...refinance to more affordable configuration.
The current "bail out" environment breeds creativity.

BTK

Steve, I was a corporate banker and never had much to do with personal banking or home mortgages. I've always been under the impression that if a lender took possession of property used to secure a loan, by foreclosure as an example, he kept the proceeds of the sale of the property and the loan was extinguished. I'm pretty sure that if the proceeds were greater than the amount of the outstanding indebtedness (including accrued interest and fees), that balance would have to be returned to the borrower. But I've always assumed that if the lender foreclosed and took title to the property, that the underlying indebtedness of the borrower was extinguished.

Will the bank be required to report the amount to the IRS and will the lender be required to pay income tax on the forgiven debt?

VK - I think you are correct, a walk away is a walk away. Clap the hands and you are free of the debt. It will follow you on your credit report but what is to stop someone from just walking away and renting for a number of years. With the glut of housing no landlord is going to refuse cash in hand on a month to month lease regardless of someone's credit background.

I think the question is more moral than financial. If you are indeed upside down or even break even then it makes financial sense to walk away. I'm sure that you could even buy a depressed piece of property afterward despite the walk away mark on your credit.

I have NO experience in the lending industry, but as everyone that has read my post know, I have opinions on what will happen. LOL

I saw, sometime during the last 6 months, a news report on a Boston news station that featured someone who knew he was going to default on his mortgage. Knowing his future credit was going to tank, he used his still viable credit to get a bank to give him a mortgage on a less expensive home. He convinced the bank that he was simply downsizing and his current home, when sold, would help him pay down the new mortgage.

The man, soon after purchasing the newer, lower mortgage home, defaulted on the first home. Simply walking away from a mortgage he no longer could pay. All this was intentional! When asked buy the reporter, if he thought this was a right thing to do, he stated something like "Why not? I've got to take care of me and my family first."

So, do I think that people will continue to walk away from their homes? You bet!

Human nature, such as it is, shows peoples true colors in times of trouble. Dishonest people will be dishonest. Honest people will struggle, but not walk away from their problems.

As I've said in another thread: Our government, though well intended, opened a can of worms with the Community Reinvestment Act. Instead of helping people with less than good credit obtain loans, as I'm sure was the only intent of the program, it opened the doors to everyone who wanted to buy their McMansions, to flip homes for profit and otherwise use the program for their own financial stupidity. Look where we are now, because of government interference in the natural processes of lending practice.

Here's how the accounting for bad debt works for a bank.

Bank examiners and the public accountants require that assets on a bank's books be "marked to market". For a bank a loan is an asset. Let's say that a bank had a $100,000 mortgage loan on a house. When the loan was made, let's say the house was worth $120,000. As real estate market values dropped, let's say the market value of the house--the collateral for the loan--dropped to $80,000.

Everything would be OK for the bank so long as the borrower stayed current with his mortgage payments. However, once the borrower became delinquent in his payments, the examiners and accountants would require that the bank mark the loan to market. Using the above example, the bank would have to write off the portion of the loan greater than the value of the collateral less the estimated expenses of liquidating the collateral. Again, using the above example the bank would probably write the value of it's loan down to around $70,000-75,000 (the $80,000 alue of the house less another $5,000-10,000 that it might take to foreclose, maintain and sell the house).

If the bank's proceeds from the sale of the house after expenses were less than the marked to market value they had in their books, they'd have to take another write-off to reflect that amount. If they actually received more from the sale of the house than they had already written off, they would take that amount into income.

The bottom line on houses that have to be foreclosed on and then sold by the lender is that there is no income to tax--only a substantial loss. Of course, if the bank has other lines of businesses that are profitable like credit cards or investment banking, the losses they take on their home mortgage business would offset any income the bank earned on those other businesses and any taxes would only apply to the net income.

Another real problem for banks is the effect of bad debts on their balance sheet and capital accounts. A bank, whether regulated by either the federal or state governments, is required to maintain a certain "capital ratio". Let's say that the required capital ratio is 20% of the assets on a bank's books. When he bank writes off assets, it reduces their capital accounts directly. So unless they add capital by retaining earnings or selling more equity, they have no choice other than to reduce assets to maintain the capital ratio.

That's what's behind the Fed's investing in the banks in the form of preferred stock. That investment can be added to the bank's capital to permit them to either maintain the assets on their books or even create more assets (loans) based on their new capital ratio. The problem that the banks seem to be facing now is that the amount of money invested by the Fed is insufficient to increase their capital ratios because the losses they are experiencing, as the result of more and more loan deliquencies and forecloses are greater than the amount of new capital the Fed is injecting into the banks.

So my theoretical question that started this thread has very real consequences that will effect all of us. The more borrowers who decide to simply walk away from their houses because their value is less than the amount borrowed simply makes the banks weaker and weaker. Their capital simply won't permit them to increase lending. In fact, they may have to continue reducing the amount of their loans.

While the American public tends to think that the $700 billion approved by Congress is a big number, it really isn't when compared to how much the European countries have injected to save their banks. It's a sad thing to say, but even what we consider to be a huge outlay of taxpayer money does not appear to be even close to what will be needed to permit the banks to begin lending again--getting money into the economy in order to begin the process of economic growth.

We are all facing very tough times--much of which history will say was caused by too much debt created by both the public as well as our government. This problem is going to take quite a while to get fixed--probably years.

And it is going to get worse for many over the next couple years.

With all of the talk of "tight credit" is the realization that houses are taking an across-the-board 20-25% reduction in value. I know the house I'm trying to sell in DC I'm going to take $100+K loss at minimum, since I found myself having to buy in mid-2004 (when prices were at the highest) and now sell when things are tough. We've had to be realistic in pricing the place at a rate which makes it "mortgageable" (below what we paid for it) and still it's been slow. As is always the case, there will be those who make money at the same time others lose money, but that's business.

Any boost in consumer or homeowner credit that is not tied into keeping the money circulating within the community (as opposed to shipped outside the country for Made-in-Elsewhere goods) will only feed the problem. It is impossible to exit a recession while being upside-down continually in balance-of-payments.

1) In the 80's S&L debacle, I know of several instances where the banks approached underwater homeowners with a demand to increase their equity in the property. Of course few people did this, but my question is do you know if banks still have that legal option as most mortgages are written today?

2) Also in that time, the IRS was nailing folks for tax on the "gain" realized on the forgiven portion of a mortgage debt. This subject has not some up in any recent discussion I've heard. Do you know anything of the status of this today?

I'd keep repaying my debts. When you borrow money, you pay it back, not walk away. Something my daddy taught me.

This whole thing started when the government forced banks to make sub-prime loans to people who couldn’t afford to make the payments in the first place. Likewise you had people purchasing homes at the peak of the price bubble (how stupid is that) getting interest only loans, 100% financing, etc. Everyone and their mother knew the housing prices were going to slip back (they always do.

My philosophy is no bail outs period and let the market sort things out. The tax payers are going to get soaked into the trillions of dollars when this is over and so far it’s not helping one single bit nor is the money being used how it was intended. The bailout is a scam and serves nothing more than to allow the government to get control over more of the private sector. The government largely caused this mess and now they are forcing us to pay for it. The second half of the root cause is just plain financial stupidity by some home buyers and others that do not live within their means or do any kind of financial planning even on a simple level.

They way to fix this problem is for the government to step out of the way, lower personal income taxes, cut cap gains and let the private sector fix this. I think we’ve all been around long enough to know government doesn’t fix things they break things.

Regarding the credit issue, I’m sure it’s out there but I frankly haven’t personally seen it. My bank just raised my CC limit… again. I have no problems at all getting car loans, home equity loans or anything else I want. The banks seem quite eager to loan money and in fact I just inquired about a loan on some property I was considering and the bank said no problem at all and I’m just Joe the Plumber, no one special.

Originally Posted by dklassen

I'd keep repaying my debts. When you borrow money, you pay it back, not walk away. Something my daddy taught me.

This whole thing started when the government forced banks to make sub-prime loans to people who couldn’t afford to make the payments in the first place. Likewise you had people purchasing homes at the peak of the price bubble (how stupid is that) getting interest only loans, 100% financing, etc. Everyone and their mother knew the housing prices were going to slip back (they always do.

My philosophy is no bail outs period and let the market sort things out. The tax payers are going to get soaked into the trillions of dollars when this is over and so far it’s not helping one single bit nor is the money being used how it was intended. The bailout is a scam and serves nothing more than to allow the government to get control over more of the private sector. The government largely caused this mess and now they are forcing us to pay for it. The second half of the root cause is just plain financial stupidity by some home buyers and others that do not live within their means or do any kind of financial planning even on a simple level.

They way to fix this problem is for the government to step out of the way, lower personal income taxes, cut cap gains and let the private sector fix this. I think we’ve all been around long enough to know government doesn’t fix things they break things.

Regarding the credit issue, I’m sure it’s out there but I frankly haven’t personally seen it. My bank just raised my CC limit… again. I have no problems at all getting car loans, home equity loans or anything else I want. The banks seem quite eager to loan money and in fact I just inquired about a loan on some property I was considering and the bank said no problem at all and I’m just Joe the Plumber, no one special.

I agree with you 100%

A little off topic but does anybody remember the reason given for the establishment of the Department of Energy during the Carter Administration?

It was very simple, and at the time everybody thought it appropriate.

The Department of Energy was instituted August 4, 1977 TO LESSEN OUR
DEPENDENCE ON FOREIGN OIL.

And now it's almost 2009, 32 years later and the budget for this necessary department is at $24.2 billion a year, they have 16,000 federal employees, and approximately 100,000 contract employees.

Ah yes, effective, efficient bureaucracy. And now we are going to turn the banking system and the auto industry over to them with billions of dollars of our tax money for a problem the government says they can fix.

Things that make you go hum...

I’ve got to say that it really frosts me that the stereotype of people who “choose” to walk away from their mortgages is that they are irresponsible, credit card toting shop-aholics with sub-prime mortgages who never should have been allowed to buy a house in the first place. Certainly some of you must know one of the countless young couples for whom this just doesn’t fit!

If not, let me tell you about one young couple I know well. Family consists of father employed full time, mother now employed full time, and 1 y.o. baby. Conventional mortgage, car payments for 1 car (the other paid off), student loans, and medical bills for a c-section that was not fully covered by medical insurance.

He was downsized about a year and a half ago – got another job right away, but there were medical insurance issues – thus one of their bills. He now commutes 2 hours each way. Then her job moves. She now commutes 2 hours each way. They would like to move closer to work but can’t sell their house for enough to cover remaining mortgage. Figure they would still owe almost $40K. Both jobs are vulnerable to the economy, so both take second jobs. Now child care is an issue and another big expense.

Bottom line is stress is taking a toll on their health, their marriage, and the baby is spending way too many hours in day care. They are both discouraged and don’t see any way out. They are not planning to walk away from their mortgage but I wonder what they will do if either or both of them lose their jobs.

And the really sad thing is I know 3 other young couples in a similar situation. All are good solid responsible people who were doing what they were supposed to do. The details change but the impact of having a house that is worth lots less that what you bought it for doesn’t. So, please, spare me the stereotype.