Walking Away and Short Sales

Calculated Risk takes a look at Walking Away and how pessimistic to be about the future. The post reviews Professor Roubini's article: The worst is ahead of us rather than behind us in terms of the housing recession and its economic and financial implication. (Subscription Required)

While the whole thing is a good read - lets pull out some interesting numbers. This paragraph has so much info that it is worth taking a look at (and, yes, it really is this long) -

The argument for a trillion dollar of losses on mortgages alone is based on the following three parameters (two of which an undisputed while a third is more subject to uncertainty. First, let’s conservatively assume that home prices fall about 20% rather than 30% so that only 16 million households are underwater; this assumption is not very controversial as most now would agree that a cumulative fall in home prices of 20% is a floor, not a ceiling to such price deflation. Second, lets assume – as Goldman Sachs does – that a foreclosed unit causes a loss of 50 cents on a dollar of mortgage for the lender as, in addition to the fall in the home price one has to add the large legal and other foreclosure costs including loss of rent on empty properties, risk of the property being vandalized and cost of maintaining an empty property before resale. Third, lets assume – and this is more controversial – that 50% percent of households who are underwater eventually walk away or are foreclosed. Then, since the average US mortgage is $250k total losses from borrowers walking away from their homes are $1 trillion. Goldman Sachs agrees with me on two parameters (20% fall in home prices and 50% loss on a mortgages) but more conservatively assumes that only 20-25% of underwater home owners will walk away. In this case mortgage losses would be “only” $500 billion. But home prices may likely fall more than 20% and with a 30% fall in home prices 21 million households (40% of the 51 million with a mortgage) would be underwater. So, there is certainly uncertainty on how many underwater households will walk away but given the recent evidence of subprime but also near prime and prime borrowers walking away even before they are foreclosed one can be pessimistic on this.

So the current conservative estimate is that house prices will fall 20% from peak, which will cause 16 million households underwater.

The next interesting number is that every foreclosed mortgage costs the lender 50 cents on the dollar. This makes us wonder why most lenders do not try to streamline the short-sale process. With the lenders taking such a potential hit the best thing would be to take a short sale - a known loss now rather than an unknown, potentially huge loss later. The potential costs of having a foreclosure appear huge to the lender - these include "loss of rent on empty properties, risk of the property being vandalized and cost of maintaining an empty property before resale."

Lastly the prediction that 50% of those underwater will go to foreclosure or walk away. That would be 8 million households going into foreclosure or walking away.

The post concludes -

One of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes.

We think walking away already is becoming acceptable for the middle class. In someways it is even more acceptable than going into foreclosure - walking away shows some control over the situation and foreclosure illustrates none. Either way your credit score takes a huge hit. The smartest thing would for a massive industry wide push to streamline short sales. This would prevent walking away and foreclosure, while reducing the huge potential loss to the lender. It may be the only way to prevent a total meltdown. It also sounds like it would be in the best interest of the sellers, the lenders and the potential buyers.