Just as the housing market has started to turn up, Fanne Mae and Freddie Mac, the housing guarantee agencies are loosening the rules on homeowners walking away from their mortgages. It used to be that only way to get out of a mortgage was to stop paying and let it go into foreclosure. Now, as Bloomberg’s Kathleen Howley reported yesterday, a few homeowners will be able to walk away from underwater properties, with new policies going into effect in March.
Under the old rules, homeowners who kept up with payments were effectively punished for doing so: stuck in houses worth much less than they paid, they were nonetheless ineligible for foreclosure aid programs. The revised rules give those folks a break — although with a raft of restrictions. They apply only to homeowners faced with hardships such as illness or job changes, and then only if 55 percent of their income goes to debt payments. And in some cases they’ll be asked to pay part of what they owe.
In return, the agencies will not try to collect a “deficiency judgement,” pursuing home owners for the remaining debt. That small accommodation elicits indignation from commentators. As one puts it in Howley’s story, “It’s an extraordinarily generous approach for companies still in debt to the American public.”
Actually, it’s not. In an audit released last October the Federal Housing Finance Agency found that in 2011 Fannie and Freddie pursued deficiency judgements on 35,231 accounts (for comparison, they foreclosed on about 342,000 properties). The total recovery on those accounts was $4.7 million — just $133 for each deficiency, or 0.22 percent of what the agencies were owed. The money Fannie and Freddie get back in the typical case is so small that even a token payment homeowners make as part of a deal is likely to exceed it.
It’s well known that some “non-recourse” states, like Nevada and California, bar deficiency judgements in many cases. Less well understood is that even in cases where they are theoretically possible, the judicial procedure makes them impractical.
The deficiency judgement is a club held over the heads of debtors, a scare tactic far more useful in persuading debtors that they should keep making payments than in recovering money when they don’t. Nonetheless, the idea that homeowners might not be pursued for the money they continue to owe still creates outrage among those who believe it violates the moral principle that debts should be paid.
That outrage has been with us since the early days of the mortgage bust, with guardians of public morals decrying the dangers of letting deadbeats walk away from their loans. Sometimes that’s been accompanied by nostalgic claims that upstanding Americans of the past would never have simply walked away from their debts (not true: even the term “walkaway” dates at least as far back as 1962).
Leave aside that the reason deficiency judgements are so hard to collect in the first place is that states made it that way to avoid (obviously without success) the lending excess of past land booms. Worth asking here is what the deadweight loss to the economy has been of scorched earth efforts to squeeze the last bits of money from foreclosures. Homeowners already sinking into a debt trap end up letting utilities get turned off or cars break down, while options like moving to regions with better job prospects disappear.
So more debtors are pushed to seek direct or indirect support from the government, and ultimately the costs of that can easily a few extra months of house payments or the $133 recovered in a deficiency case. Having gotten $187 billion in taxpayer bailouts, it seems reasonable for Fannie and Freddie to take that cost into account, too.