Jingle Mail:

David below comments on the new trend toward voluntary foreclosures. In the business I understand that this is referred to as "jingle mail," where the borrower simply drops the keys into the mail to return to the lender. For those who are interested, I commented a bit on the two theories of foreclosure awhile back here.

Foreclosure can occur either because borrowers can't pay their mortgage (distress theory) or because they don't want to pay their mortgage (option theory). It turns out that the prevailing theory in economics is the option theory--foreclosures rise when property values fall because borrowers then have a valuable "put" option to permit foreclosure. Most empirical work historically supports the option theory as well, rather than the distress theory. Commenters to David's post note some of the factors that at the margin would be expected to increase the value of the option, including antideficiency laws (as in California) as well as the new Mortgage Foregiveness Debt Relief Act. Of course, even where a state provides a right to recourse lenders often will not pursue it if they think that the borrower is essentially judgment-proof.

As one would expect, default and foreclosure is also substantially higher where the borrower puts down no downpayment or a minimal downpayment.

Query for readers--has anyone seen any empirical studies of whether there is any effect of antideficiency statutes on foreclosure rates? Theory suggests that there must be some effect, but I have not found any empirical work on point. Most of the states with the highest foreclosure rates right now are those with antideficiency laws. Also, if anyone knows of a single comprehensive list of states with antideficiency laws, that is something I've been looking for as well. I've found one list, but it is not terribly user-friendly.

I'm putting the finishing touches on an article on the subprime meltdown that I'll be posting in a few days for anyone who is interested. The article provides a more detailed discussion of the theoretical and empirical work around these question of foreclosure.

has a summary of foreclosure laws by state.

An interesting new trend has developed in California. For $1000 a company in San Diego instructs homeowners how to send their keys to the lender and walk away from the home with no liability.
2.14.2008 2:05pm
jfalk:, where the relevant variables are taken from the credit decision variables in
2.14.2008 2:09pm
Richard Aubrey (mail):
A friend of my son had to move for business purposes. He had, due to the bust, substantially less equity than he owed. He had not, as it happened, refinanced (used the house like an ATM), but had put little down.
So he allowed foreclosure.
I guess that's jinglemail.
2.14.2008 2:10pm
Zywicki (mail):
KJJ: Thanks!
2.14.2008 2:22pm
CrazyTrain (mail):
Todd, I know you were one of the few people in the world (besides the credit card industry and their bipartisan hacks in the Congress and the White House) who thought the bankruptcy bill was a good idea, but you should be a little honest. Referring to "antideficiency laws (as in California) as well as the new Mortgage Foregiveness Debt Relief Act" is woefully misleading.

The rule in California is long-established. In a free market, banks know the rule is non-recourse for residential mortgages (i.e., they can only collect against the real estate and not against the individuals). It's been this way forever. Banks, nevertheless, chose to take the risk by lending outrageous amounts of money, with no down-payment, to people who couldn't afford it. To compare that to the Mortage Forgiveness Debt Relief Act is absurd -- that is an after-the-fact bailout for people which is totally different from California's non-recourse rule. I know this is just a blog post, so I hope the article you are writing is more clear on these differences.

On a serious note: Do you get paid any consulting fees by any groups in the credit industry? Nothing wrong with that, but if that is the case, I think you should disclose that.
2.14.2008 2:23pm
Zywicki (mail):
Nothing I've said is inconsistent with what you've said. The theories are positive theories about what leads to foreclosures. What to do about it is a normative question—but obviously the policy implications differ depending on how many foreclosures are caused by distress versus how many are caused by exercising an option. I can't see any coherent policy rationale, for instance, for bailing out real estate speculators who are now exercising an option or the lenders who lent them money with no downpayment, yet some of the proposals that have been floated are premised on the assumption that everyone in foreclosure is there because they got ambushed by payment shock.

Unless you know something I don't, at least some borrowers in foreclosure are speculators who are voluntarily exercising an option and some are being forced into foreclosure involuntarily. Unless we know how many of each are in foreclosure, and how many more of each are headed for foreclosure, then I don't know how we can produce a coherent response to the problem.
2.14.2008 2:53pm
TomHynes (mail):
As a practical matter, maybe all states are like California.

I doubt that many people continue to pay anything on mortgages after they have been foreclosed upon. Is there any way to find out?

Also, in a state with anti-deficiency, a short sale solves the problem. "I can stay for a year by declaring bankruptcy. Or I can sell it back to you, Mr. Bank, for the value of the mortgage. My credit stays good and you get the house in better condition and earlier than you would otherwise"
2.14.2008 3:41pm
Zywicki (mail):
Thanks for those links--the references in the Pence paper led me to exactly what I was looking for.

TomHynes: That's an interesting point. Perhaps related is that the data I've seen finds that for some reason subprime loans are slower to foreclose than are prime loans (if I recall correctly, subprime loans take 4 longer to actually foreclose).
2.14.2008 3:50pm
CrazyTrain (mail):
Tom -- That's not right. There can be serious tax differences to the borrower if the loan is recourse. If the bank chooses to forgive some of the loan beyond the value of the property then the loan forgiveness would be income to the borrower and taxable as such. Big and very practical difference between recourse and non-recourse.
2.14.2008 4:05pm
Both of these threads are quite interesting. Just intuitively, I think that states mandating jingle mail definitely would have a higher foreclosure rate. By the same token, those states ought to have a lower incidence of personal bankruptcy filings.
2.14.2008 4:53pm

I believe that tax consequence was just repealed in the last 6 months.
2.14.2008 5:21pm
I doubt that many people continue to pay anything on mortgages after they have been foreclosed upon. Is there any way to find out?

Generally lenders do not accept any partial payments (other than the full arrearages) once a property is in preforeclosure.
2.14.2008 5:57pm
Would someone please answer a naive question? Why does it make a difference whether there has been a substantial down payment? Why isn't this just a sunk cost?
2.14.2008 7:25pm
Zywicki (mail):
Because people default when the house is no longer "in the money" especially if it is nonrecourse. So, typically, if you put down 20% then you still have some equity in the house until it falls by more than 20%. If you put nothing down and the house falls in value into negative equity then it becomes easier to walk away.
2.14.2008 8:32pm
Would someone please answer a naive question? Why does it make a difference whether there has been a substantial down payment? Why isn't this just a sunk cost?

The assumption is that someone who is able to produce a substantial down payment is more financially stable or has more financial resources than someone who has a $0 down payment. Also someone with a large down payment has more incentive to make his or her mortgage payments than someone with nothing invested in the property.
2.14.2008 8:36pm

Also someone with a large down payment has more incentive to make his or her mortgage payments than someone with nothing invested in the property.

Wrong... sunk cost.

However, the reason people that make substantial down payments are less likely to end up in foreclosure because the foreclosure option is less likely to be in the money.
2.14.2008 9:00pm

Wrong... sunk cost

Whether it's rational or not, many homeowners see their down payment as an investment that they wish to recoup. This is particularly true for people who actually live in their homes as opposed to investors. Also walking away from a property creates a significant credit reporting problem that may disqualify someone from obtaining home financing for 48 months or more.
2.14.2008 9:20pm
Isn't the tidbit about lenders having to worry about their debtors being judgment proof just a teensy bit inconsistent with the claim that voluntary foreclosure is nearly always an option as allegedly shown by "nearly all empirical research"? If people have the money and are simply choosing to walk away, how can so many of them be judgment proof?
2.14.2008 9:29pm
Elliot123 (mail):
An excellent example of jingle mail was Alaska in the oil bust of '86 or '87. Lots of people gave back the keys, then bought at lower prices.
2.14.2008 9:43pm
A. Zarkov (mail):
Question. In CA can a borrower waive his rights under CCP §576 and §580? If you have no intention of defaulting on a loan and are willing to assume the risk of a deficiency judgment, why not enjoy a lower interest rate? It seems to me that CA law should not get in between the borrower and the lender. Why should I have to pay extra because CA likes deadbeats? My guess is probably not because CA is afraid the waivers would become the norm and non-waiver loans would either become too expensive or unavailable. Nevertheless in some cases you can waive rights, and once I had a buyer provide a hold harmless agreement as a condition of purchase. To make the agreement valid we needed to to sign other waiver agreements with advice of counsel.
2.14.2008 10:33pm
Crane (mail):

Wrong... sunk cost.

To normal people (those who haven't had economics classes), the label "sunk cost" doesn't necessarily make a difference. If they've spent a lot of money on something, they don't want to just walk away from it, accepting that they'll never get their money's worth back. This is why I don't really trust the standard model's assumption that people are always rational actors in the marketplace; people fail to maximize their profit all the dang time.
2.14.2008 10:40pm
A psychiatrist who learned from veterans (mail) (www):
You all are making it hard for me to want to see the government further involved in securitizing mortgage debt. I would be interested in the relative cost of puts in the California housing market and the recognized options markets. Are there price prediction theorems for an 'options' housing market? Offhand, it would seem such an actual pricing structure for housing should lead to acceleration of prices on the upside with an accelerated downside based on more people being out of the money and an increased vacated housing supply.
2.14.2008 11:13pm
R. G. Newbury (mail):
If you can put your hands on it, you might want to look at similar mortgage default statistics for Canada. The western provinces have limited non-recourse statutes, while for Ontario and eastward, mortgages are 'all-recourse'. In fact, actual foreclosure (where the mortgagee in effect buys the property for the mortgage debt) is rare.
In large part that is because the usual 'max' first mortgage is only 75% loan to value. (And mortgage insurance is a regulatory requirement for certain lenders above that level). Since there will be equity in a 75% L/V property, the mortgagor is entitled to require that a foreclosure be turned into a judicial sale, which is effectively the same thing as a sale under power of sale, but conducted with court oversight of the process.

And foreclosure can take longer than a sale under power of sale. In a sale under power of sale, the mortgagees only get their full amount due: any excess goes to the mortgagor. But it is faster and easier for the lender. It helps that any delay may be eating the borrowers equity and the value of the house may be well above the debt.

Tax laws and bankruptcy laws affect things too. Here a judgment for the mortgage debt will be visible on a credit report for 7 years. A well-advised borrower facing a default situation would make a deal to put the house up for sale (and repay the debt) without any need for a judgment. A well-advised lender always encourages a borrower to remain in the house and sell it, provided some payment can be made against the debt, since an occupied house always sells for more and the lender cannot get sued for improvident sale, if the owner makes the sale. Of course, not all borrowers or lenders are 'well-advised' or particularly rational decision makers in these circumstances.

I cannot understand why US lenders would lend to such L/V levels in a non-recourse situation: the borrower is not buying that house, he's just renting the money and the bet is whether the house is worth the amount loaned. The lender can only hope he cuts the grass and shovels the snow. Better odds at Las Vegas if the L/V is over 80%....
All in all, jingle mail basically does not exist in Ontario since there are still consequences even if you 'walk away'.
2.15.2008 12:32am
markm (mail):
R.G.: When I started a job in northern Virginia (the D.C. exurbs) twenty years ago, I could have easily got a mortgage with little or no downpayment and payments exceeding 50% of my take-home pay. This based on a job with a smallish company in defense contracting, which is a notoriously unstable business. Old hands in defense contracting will tell you to save half your pay to cover the inevitable layoffs, and in fact my employer created an entire division for one contract, and closed the division and laid off everyone when they lost that contract two years later.

As far as I could tell, what the banks were counting on was that the house would appreciate so fast that even if I had to default a few months after moving in, the appreciation would cover the costs of repossession and sale. In other words, they were expecting over 12% appreciation a year - even from modular homes. More precisely, there was a lack of building sites in the area, and they were assuming that population influx would continue bidding up the lot under the house so quickly that they couldn't lose money on the house.

I decided to rent instead. And considering that most of those people moving into the area and bidding the price of land through the roof were there for government work of one sort or another, I've always taken the claims about Reagan being for smaller government with a large grain of salt...
2.15.2008 11:42am
On the down-payment as a sunk cost:

If an automaker has built a factory, that is a sunk cost. If they decide to close the factory, that doesn't mean that they just give it away--they try to extract whatever value out of it they can.

Similarly, the down payment works as a buffer against the borrower having no value tied to the property.

As long as the property hasn't depreciated beyond the down payment's value, then the borrower has an incentive to stay. She may have lost some money, but it is to her advantage to still make payments (all else being equal of course).

Say I put $100K down on a $500K house, and it depreciates $75K. The house is now worth $425K, but the loan is only $400K. Therefore, if I just walk away, I still lose $25K of recoverable money.

Some of the down-payment is still recoverable--it's a sunk cost, but I can still extract value from what I bought with it--real value that makes it to my advantage to still make payments until I can sell the house.
2.15.2008 12:18pm
Zywicki (mail):
R.G. Newbury:
Turns out that the example you give is exactly the example used in the one paper I found to be on point, a 1993 paper in the JLE by Jones. He compares Alberta and British Columbia and finds that "in a period of sizable house-price declines, the prohibition of deficiency judgments can increase the incidence of default by two or three times over a period of sevearl years." This is the paper I found through jfalk's lead mentioned above.
2.15.2008 1:49pm
occidental tourist (mail):
Came across this alternative to anti-deficiency approach with respect to security, especially as originally detailed in David's post from CBS: Sue to enforce the note rather that foreclose upon the security.

I generally agree with Crazytrain's premise that mortgagors were on notice with respect to recourse. And the idea that real estate inflation alone would protect their capital, as absurd as it seems in these low downpayment ARM loans, seems actually a lot less bubble like than the notion that fueled the .com boom, i.e. the less profit a company makes the more likely it is on the brink of future profits.

I do think that the question of optional foreclosures is an interesting one, but I get a feeling that policy choices are being moved mostly by macro-economics , i.e., the reverberation of these bad choices on other sectors of the economy rather than the relative culpability of mortgagors and mortgagees. So some undeserved bailouts are being lavished on both at the expense of those who are renting and/or aren't defaulting.

If we're stuck dealing with this at the macro level while real estate tests for solid price levels, might be a good time to discontinue the home mortgage interest deduction and get the government to reduce its other unintended consequences in this arena.

2.16.2008 9:11am
occidental tourist (mail):
PS --

For the tax savvy amongst us. While you can shelter gains in a residential investment, do you have to? Conversely, while the foregiveness of the bank loan would be a significant chunk of income, can't you choose to take the loss on the house as offsetting.

The bank foreclosure sale for less than you owed would be evidence of the loss compared to what you had paid for the house and invested (it is the IRS, if some of the mortgage was not purchase money but was for renovation you'd have to be ready to cough up some accounting which, if you weren't anticipating a capital gains test on residential property, you might not have kept perfect track of but ought to be able to reasonably substantiate). If you had any downpayment at all, then your loss would actually be larger than the foregiveness.

2.17.2008 5:35am