Stop Blacklisting Strategic Defaulters

Fannie Mae, Freddie Mac, and all Government Sponsored Lenders, should immediately reduce or even eliminate the arbitrary blacklist period for strategic defaulters. Giving them a second chance at homeownership is both good for society and for our economy.

In a misguided effort to deter borrowers from strategically defaulting on their mortgages, our Government lenders (FHA, Fannie Mae, Ginny Mae, Freddie Mac, etc.) have imposed strict penalties on potential borrowers who have undergone a short sale or a foreclosure. In 2008, Fannie Mae extended their 4-year “blacklist” period to 5 years, saying:

The presence of a prior foreclosure action in the borrower’s credit history is evidence of significant derogatory credit and increases the likelihood of future default. The lender should consider the presence of a foreclosure as an added risk element that represents a significantly higher level of default risk. The greater the number of such incidences and the more recently they occurred, the higher the credit risk.

Why the change? Already, a borrower who walked away in 2008 wouldn’t be able to apply for a new loan until 2012.

Why extend it to 2013?

The Answer: To intimidate borrowers to keep paying.

Just like a loan shark who carries a baseball bat

Strategic Defaulters Are Responsible People

Fannie Mae believes that borrowers who have had “significant derogatory credit” are more likely to default again. Fannie Mae assumes that, to have “significant derogatory credit”, a borrower is inherently irresponsible. This makes common sense under normal circumstances, but is a false assumption in our current, turbulent environment.

Today, many borrowers are choosing to strategically default precisely because it is the most responsible thing to do.

Let’s take a look at who these borrowers are in the first place:

• They had to move but where underwater and had to do a short sale.
• They have lost their home in foreclosure for typical reasons (job loss, divorce, death, disability, medical, etc.).
• They have lost their home in foreclosure because they could not afford adjusted or recast payments.
• They chose to walk away from their homes for economic reasons.

Modern “significant derogatory credit” is increasingly the result of responsible choices by borrowers, not irresponsible behavior as Fannie Mae asserts.

Fannie, Freddie, and the other Government Lenders should look closer at each borrower. Why did they default? If it was a strategic default, what were the reasons? If someone has to move but is $300,000 underwater, are they irresponsible? Or unlucky? Did they likely learn their lesson?

Fannie’s one-size-fits-all policy is throwing thousands of responsible borrowers out with a few irresponsible ones.

Are these buyers more likely to default than other buyers?

In it’s recent reporting of July 2009 data, Fannie Mae reported that it’s “serious delinquency” rate for conventional loans increased to 4.17%. Check out this chart from Calculated Risk:

Almost 1 in 20 “regular” Fannie Mae borrowers are seriously delinquent (90 days or more).

As of June 30th, 2009, 14.4 percent of all FHA borrowers were delinquent.

Do you actually think that post-foreclosure and post-short sale borrowers would perform worse?

Isn’t it more likely that many of them would have learned their lesson and behave more conservatively?

Mass Strategic Defaults

If a borrower is underwater as millions are, they have no cash to lose. The only thing that a lender can threaten them with, is their ability to buy another house. Remove the blacklist period and hundreds of thousands more borrowers might choose to strategically default right away.

The Government’s concern about mass defaults is legitimate. Yet there are is a legitimate counter: hundreds of thousands of current would-be buyers are being forced to sit on the sidelines. This is pent-up demand that’s not being utilized.

For every distressed sale, there becomes a would-be borrower whose credit-worthiness deserves a closer examination.

Misguided Policy

It is now official Government policy to prop up home prices, making mortgage payments, taxes, and insurance higher for all of us. Hence, the billions spent on failing modification programs. Consider Did the FHA make bad loans with taxpayer money to prop up home prices?

Did the FHA knowingly make bad loans with taxpayer money to prop up the housing prices?

Was it because of political pressure?

Barney Frank says in The New York Times

“I don’t think it’s a bad thing that the bad loans occurred,” he said. “It was an effort to keep prices from falling too fast. That’s a policy .”

So now it’s official policy of the Government to prop up home prices. Ponder that for a few minutes…

Regarding home prices, they are going to go wherever they are going eventually anyway. Government drugs can slow the cancer, but they can’t cure it.

Therefore, would-be strategic defaulters are pawns in a game that the Government cannot win.

Fairness and Justice

A free-market economy depends on risks and rewards, failures and consequences, fairness and justice. However, we are living in a fantasy world if we think that our modern financial economy is anything close to free-market or fair. Instead, a cabal of old men in deep leather chairs decide what is fair and just…for our own best interests, of course .

It is human nature to try and divide and classify our peers into different groups. Defining other people helps us define ourselves. It is tempting to define the financially-unlucky as second-class citizens: they are irresponsible and deserve any punishment they have coming.

The truth, however, is that many of us are more lucky than smart …we just happened to be sitting down when the music stopped.

Had the music stopped a year or two earlier it might have been us in trouble .

The Sneetches, My Dr. Seuss

But McBean was quite wrong. I’m quite happy to say

That the Sneetches got really quite smart on that day,

That day they decided that Sneetches are Sneetches

And no kind of Sneetch is the best on the beaches.

That day, all the Sneetches forgot about stars

And whether they had one, or not, upon thars.

Let’s get off our high-horses and embrace these would-be borrowers.

After all, you may need one of them to buy your house.