Fannie Mae: Strategic Defaulters Must Wait Seven Years

Fannie Mae has decided that Strategic Defaulters must be punished. Today, the taxpayer-owned behemoth said that it would “lockout” strategic defaulters for seven years and sue them for any deficiency. Let’s be clear: Fannie Mae doesn’t really care about any individual borrower’s deficiency amount or the moral hazard of lending to them again. This threat was meant to scare homeowners and limit future defaults.

This reeks of desperation.

The Wall Street Journal reports:

“Walking away from a mortgage is bad for borrowers and bad for communities and our approach is meant to deter the disturbing trend toward strategic defaulting,” said Terence Edwards, Fannie’s executive vice president for credit portfolio management. The company said it would also take legal action to recoup the amount of lost mortgage debt in states that allow for such deficiency judgments.

Previously, the GSEs had blacklisted all foreclosed-borrowers, including strategic defaulters, for 5 years (up from 4 in 2008). For the first time, Fannie Mae is differentiating between necessary foreclosures and strategic ones.

The problem is that, for many borrowers, the decision is more gray then black and white. Many strategic defaulters probably could hang on for a while longer, but choose to take their medicine now. How will they be treated?

According to the Journal:

The government-owned mortgage-finance giant said that borrowers who walk away but have the capacity to pay for the loan or didn’t complete a foreclosure-alternative in good faith would be ineligible for seven years from getting a new loan backed by Fannie.  Borrowers with “extenuating circumstances” might be able to get a new loan sooner.

In other words, it’ll be a judgment call by a lower-down at Fannie Mae.

Are They Bluffing?

With fully 1-in-4 homes with mortgages underwater…probably 1-in-3 if you took selling costs into consideration, mass strategic-default is a real threat – one that could send the economy into a tailspin. It is understandable why a lender would try every trick they can think of to suppress walk-aways.

I wonder if they’ll have the cojones to go through with it. I can see them standing tough for a couple of years, then eliminating the penalty when they realize that they need these thousands of would-be-buyers as customers again.

Or, at some point, the private mortgage market will come back and. Once home prices have truly bottomed, banks will realize that today’s strategic defaulters aren’t toxic at all. They could even profit by charging extra fees.

The point is, I doubt that strategic defaulters will really have to wait seven years. Heck, I doubt today’s foreclosed borrowers will have to wait five.