Guest Post: Why Do The Rich Default on Their Mortgages? Because In California and Arizona, They Can

Tyler Durden's picture

Submitted by David Fiderer

Why Do The Rich Default on Their Mortgages? Because In California and Arizona, They Can

Why throw away good money after bad? It’s a frequently-asked question in the five most expensive real estate markets in the mainland United States--San Jose, San Francisco, Orange County, Los Angeles and San Diego--where over a million home mortgages are under water. That’s nine times the number in all of New York State. In fact, that’s more than 30 other states combined.

“If you default, your credit score will take a hit,” advises Jane Bryant Quinn on CBS MoneyWatch. “But as long as you pay all your bills on time, both before and after the default, your walk-away will become less important after a couple of years.”  No one is counting on a strong recovery of home prices any time soon.  Even during normal times, real estate markets go through multi-year cycles. The value of a typical home purchased in Los Angeles in 1990 fell by 25% within five years; by 2000, the cumulative home price appreciation after a decade was exactly zero.

Of America’s 11 million homeowners with negative equity, a majority live in the four sand states where the real estate bubble was concentrated--California, Florida, Arizona and Nevada. Over three million live in California and Arizona, where a borrower can hand over the keys to the lender and walk away. These are two antideficiency states, where the lender has no recourse beyond the collateral property.  So of course it makes sense that wealthy homeowners would default on their mortgage loans. They live where in places home prices were the highest and the fell the steepest, and where the consequences of default are the least onerous. The New York Times overlooked the “where” and “why” of the story.

The wealthy are also less dependent on consumer credit. They can buy cars for cash; and charge expenses on their debit cards. So for them, it’s easy to make a fresh start. But the mortgage debt doesn’t go away. It’s simply pushed off to the banks insured by the Federal government. The rest of us pick up the pieces.

In Phoenix, total home mortgage debt exceeds the market value of all homes with mortgages. The 58% of homeowners with negative equity are seriously under water, while the remaining 42% with positive equity worry about continued deterioration of their home values. (CoreLogic’s disclosures do not include homes with no mortgage.)

"Even if the economy is the, quote, No.1 issue,” said John McCain when he was running for President in January 2008, “the real issue will remain America's security.  And if they choose to say, ‘Look, I do not need this guy, because he's not as good on home loan mortgages,’ or whatever it is, I understand about that, I will accept that verdict,” he told Florida voters. “I am running because of the transcendental challenge of the 21st century, which is radical Islamic extremism." Since then, Phoenix home prices have fallen by 38 percent. No wonder he wants to talk about immigration.

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God's picture

Why Do The Rich Default on Their Mortgages?

There is no shame in playing the game...

VK's picture

But God, you told us it is easier for a camel to go through the eye of a needle than for a rich man to go to heaven. Have you been lying to us for 2,010 years?

malek's picture

As they say in Germany:

"Ist der Ruf erst ruiniert, lebt sich's gänzlich ungeniert."

roughly translates to

"Once you ruined your reputation, one can live completely uninhibited."

snowball777's picture

Ahhh....but their HELOCs...that stink will follow them all the way to Rodeo.

aerojet's picture

"Rich" and "HELOC" don't jive with me.  

snowball777's picture

Rich people lose jobs (Hi Fab Fab!!!) and desperately try to continue the affect of wealth all the time, except they call it "a cash flow problem".

FEDbuster's picture

As my brother used to call himself a "low cash flow dude".

Eternal Student's picture

Exactly. Add to this the fact that people who have refi'd also lose their no-recourse status, which is probably most mortgages (given how much activity there's been to grab the lower interest rates).

The article also left out the reason why no-recourse originally came about. There was a time when people thought that it was wiser to let people get back up on their feet, and give them a chance again. With no-recourse and the way the debt-collection agencies are going, the general theme now is to keep people in debt forever as debt-slaves to the Bank.

FrankIvy's picture

This was the whole point behind the 05 bankruptcy revision.  The main change there was that 50% of the population could be forced into chap 13 repayment rather than the fresh start promised by chap 7.

Best financial advice I ever gave was to my neighbor, who "wanted to do the right thing," and was going to file chap 13 even though he qualified for 7.  I earnestly told him to get his head out of his ass.  CCCs charging him 19% and he wanted to "do the right thing" and pay back his bills.

A few months of hell, some public shame, and man they were good as new and happier than ever.

Then they bought a car.


TooBearish's picture

AUDJPY cross! holy crap ES  divergence #12

Alethiometer's picture

Hope you were riding the 300 pip EURUSD move this week


Kat's picture

The New York Pravda is only interested in fomenting a class war.  So, of course, they are going to skip the part about incentives.  The antideficiency law is the problem.

Not surprising.  All the government does is pass laws that create more problems than they solve.


pan-the-ist's picture

I'm sorry, why is it a problem to foreclose on a house again?  If the asset is not worth the debt, why would you keep it?  Is it your duty to your fellow man to remain a wage slave?  What's wrong with you?

MachoMan's picture

So, what should the mortgage companies have done?  Well, they could have charged higher rates given the lack of recourse...  could have demanded additional collateral...  it's not like their hands were tied.  If certain states want to be less competitive on loans, that's their business.

We always end up back at the same issues...  can companies accurately assess risk?  Do the companies issuing the loans keep any skin in the game?  Can we ensure appraisers are objective?  If an overarching company is going to purchase all the bad loans, can we ensure they are purchased from initial lenders at a fair price and subsequently liquidated/sold at a fair price, upon proper auction terms.

I also fail to understand the stigma associated with defaulting on a loan held by a GSE paid for by your own tax dollars.  Although homes carry sentimental value few other assets hold, their purchase is still a business decision.  A decision that was made in full and complete understanding of the law at the time...  hedge accordingly...  and if not, get the government to bail you out.

Kat's picture

I have no idea what you're talking about. 

I have no problem with foreclosure.  If the borrower can't pay, the lender should foreclose.  The problem is that that antideficiency laws in our system of socialized losses and privatized profit shift the responsibility for debt from the debtor to everyone else.

But, given antideficiency laws, the borrowers are making a perfectly logical decision. 

It is your duty make good on the contracts you entered.  Yes.  It is not the duty of your fellow man to backstop your stupid decisions and unfortunate trades.

pan-the-ist's picture

When I signed my mortgage I made no agreement with the pension that bought the MBS my loan was bundled into, and wasn't even aware that a CDS existed.  I made an agreement with a bank that I would pay my loan with my house as collateral.  On the face of it, my walking away should be between me and my bank, it is unfortunate that the banksters have setup a system to privatize gains and socialize losses.

RockyRacoon's picture

You have a good point.  Same could be said of car loans.  What the lender does with them is of no concern to the borrower.  If I want to stop paying on the car, and they come and get it, it's nobody's business.  There is no "moral clause" in any of these contracts.

bonddude's picture

Problem is corporate America walks from

loan obligations everyday. Illegals walk.

crooks walk. Everyone leaves the balance to be 

picked up by John Q. US Taxpayer. Hence,

"drop off the key, Lee." 


By the way, who holds the MBS and how are 

they being priced these days. FNM,FRE ???

Kat's picture

Judging by your reply, you don't seem to understand what an MBS or a CDS is. 

The contract you signed is to repay the mortgage with your house as collateral - to WHOMEVER owns the loan.  If the bank sells itself to another institution, you then owe th money to the institution that bought the bank.  Regardless of who is currently lending you the money, you owe it.

The banks have no power to "set up a system" to socialize losses.  Only your "friendly" government has that power.  As long as the government has that power, banks will try to buy it.  To blame the banks for doing this is as inane as blaming the rich for walking away from upside down mortgages when the banks can't go after them for the deficiency.  And there are still people who want government to be more powerful, which means that there will be more reason to buy government power.

pan-the-ist's picture

So the people who bought the MBS should have known better?  As you say, the government works on behalf of the banks.  What's your point again?  Oh, that's right, you don't have one.


Cpl Hicks's picture

Meant to note your changing your avatar from one gangster to another...nice!

Paper CRUSHer's picture






Sean7k's picture

Why do the rich default? Because they understand wealth preservation, making financial decisions based on facts and not sentiment. In a few words, they are not brainwashed by social conformity.

Good chart on Jesse's cafe americain about this very subject. 

The banks sold this debt to generate fees, without regard for risk assessment- because they knew they would be bailed out. This feigned outrage over defaults is laughable and another attempt to guilt those willing to buy the argument. 

The banks loaned against collateral. They are being given back the collateral. Isn't this how collateral works? Isn't this why banks receive an interest payment and down payment? Their failure to do due diligence is everyone else"s fault? Let them fail!

pan-the-ist's picture

The rich are rich because they don't spend money when they don't have to.  It really is that easy.

John Self's picture

I agree.  But I'm also not sure how many of the people we're talking about are truly rich.  It's easy for them to look that way from the perspective of a blue-collar worker, especially if the defaulter carries a $1MM+ mortgage.  But in many of the bubble areas, a $1MM mortgage doesn't get you that spectacular of a house.  You could easily be a upper-middle class worker drone, still living paycheck to paycheck, and be in one of those houses.  I'm guessing maybe 3000 sf, 4 or maybe 5 bedrooms in a fairly upscale neighborhood.  (Or potentially a lesser house with a home equity line also playing into the equation.)  Nice?  Sure.  Much of the country, and nearly all of the world, would kill to live there.  But not necessarily the family that can suddenly start buying cars with cash after the default.

I'm sure there are some strategic defaulters, but I suspect that it's far fewer than the NYT wants us to think.

pan-the-ist's picture

And we agree that those people should never have been in those houses, the reality, as most of us here agree, is that the housing market will deleverage, when that rock rolls off of Atlas's back, it's going to do some damage, there is no avoiding it.

(BTW, i noticed the site's spell check doesn't like the work deleverage - is this it a forbidden word?)

The Rock's picture

"But in many of the bubble areas, a $1MM mortgage doesn't get you that spectacular of a house.  You could easily be a upper-middle class worker drone, still living paycheck to paycheck"

I agree. I live in the LA area and there are a LOT of people who are in that situation. Yes, the market crashed for the lower end homes but it hasn't hit the "higher end" homes of $800k+ yet. Just like on the way up there was a delayed reaction for the higher end homes to participate in the bubble rally, it's the same thing on the way down. A lot of those homes only went down 20% from its peak. The next leg down will happen when these option ARMs reset this fall.

And just like the article states, I know someone who can actually afford his home of $900k who said that if the value of his home went down to say $600k, that he would walk away.

Yes We Can. But Lets Not.'s picture

Friend of mine's 5 year ARM, based on one-year LIBOR index, resets next month from 5.25% to around 3.25%.  I'd imagine a lot of resets will aid the borrowers...

Strom's picture

The issue on most loans will not be the reset, but the recast. Once they have to start paying amortization, the payment will increase significantly. Especially on Option Arms where they made the minimum payment and are now at something like 125% LTV (that's ORIGINAL appraised value, not current value). 

Kat's picture

That's part of it.  The other part is that they are very much more productive than the average person and therefore create a lot of wealth.  You have to have to first create the thing you are not spending frivolously.

pan-the-ist's picture

"Rich" is obviously a relative thing.  There are plenty of stories of frugal people who live within their means and manage to save a lot of money over their lifetimes.  Most of us, me included, aren't forced (yet) to live within our means.  Some of us think we do, but we'll be put to the test soon.

weinerdog43's picture

"...they are very much more productive than the average person and therefore create a lot of wealth."

Rubbish.  By this analysis, LeBron James is much more valuable to society than the trash collector, sewer worker or plumber. 

RKDS's picture

Didn't you get the memo?  Having lots of money irrespective of whether you earned, stole, or inherited it, automatically makes you better and more important than everyone else.  I swear, sure are alot of communists on ZH these days...

contrabandista13's picture

"... By this analysis, LeBron James is much more valuable to society than the trash collector, sewer worker or plumber....?

He is, however, not because I made him so, because you made him so..... So far as I'm concerned, LeBron can drop dead tomorrow and I wouldn't bat an eyelash..... His agents and PR people would probably have a cow but I wouldn't give a shit... The privilege of being rich is that you don't have to stand in line for anything, not even in the line for the gallows....

As my father used to say... "there are two classes of people in this world, those who are bought and sold and those who do the buying and the selling. Pick one...!" Believe it or not, even with his income, LeBron is a member of the former class. He may know how to play basketball but he ain't no player, in the Biblical sense of the word. Power is a currency in and of itself and the powerful are fearless.

Best regards,


Chump's picture

"Valuable to society" is bullshit collectivist jargon.  Value to whoever is paying the salary is all that matters.  Those sewer workers and trash collectors may have an important job, but anyone with working arms and legs who can left up to approximately 75 pounds can do it.  There are a lot of people who fit those criteria, so the job doesn't pay as much as others.  It's simple supply and demand.  And most plumbers earn a pretty penny.  The job requires a fair amount more skill than collecting trash, and there are fewer people who pursue developing that skill.

LeBron is worth millions to someone(s) because he can dunk a basketball and entertain tens of thousands of people at a time.  Those tens of thousands of people spend money on merchandise, tickets, beer, premium TV, etc., etc.  Right or wrong, it doesn't matter what you think.  You're not paying the bill.

"Value to society."  Don't make me vomit.

Kat's picture

Well, technically, "society" is paying to see LeBron which is what gives him all that money.  So, I guess society thinks he's pretty valuable :)

So, I guess for all those who whine about "value to society" should just first understand what the F**k they're talking about first, eh?

Kat's picture

Yes, LeBron is worth more because people will pay to see him and very few people in the population can do his job.  Anyone can be a sewer worker or a trash collector and plumbers make more than they do because they are more skilled.  You see now?

Most people who have a high income obtain that income by being valuable to their employers - more valuable than the compensation they are being paid.  They produce more than other employees.  Or an entreprenuers creates something so useful that people happily part with their hard earned money to buy it.  They create wealth.  There are exceptions for rent seeking corporations, obviously.  But, generallly speaking.


aerojet's picture

I would file this under don't hate the player, hate the game.

snowball777's picture

If I was an executioner, I might not be able to resist using that line on a 'customer'.

moneymutt's picture

its a lot more complicated than that, this article gives a false, simplified perceptions....HELOCs, refis etc. change rules drastically....and if you were in your house more a few years, with the dropping rates, almost everyone has re-fi'd. There are many ways banks can still come after people after they leave, beyond taking the security, the house and there are starting to. In Florida, banks are starting to come after people several years after they walked away.

Cali legislature has been debating this issue, the Realtors want people to be able to walkaway in all situations, because they want future customers, banks, are fighting it. Tough to choose to side for one or the other of those two. 

Please, zerohedge, get smarter commentary than this, at least get facts right...people in Cali and FL may think they can walk away without further collections but this is often no the case.

Mish and many housing blogs have posted tons of info on the labyrinth of rules around is stupid for someone writing an article not to know more.

malek's picture

You're right,
but the article at least mentions things like antideficiency states, compared to the NY Prawda...

So it's a good one for starters.

Yardfarmer's picture

the American mantra: privatization of profits, socialization of losses...

RicardoM from Temecula CA's picture

I have never heard anyone pan antideficiency statutes. They are a holdover from a raunchy period where individuals lost their homes and the big, bad banks would pick on the sissies trying to collect the whole amount they lent. I am a conservative and I am 100%, nay 1,000% all for antideficiency statutes. IN CALIFORNIA, DID THE JOURNALIST NOT KNOW, THAT BANKS CAN FOREGO THE PROCESS OF TRUSTEE FORECLOSURE AND GO TO COURT AND GET THEIR DEFICIENCY JUDGMENT? Antideficiency only applies to the creditor using the out-of-court remedy.


Shet, I have never heard anybody bitch about anti-deficiency legislation. What is the world coming to?

dussasr's picture

People in nonrecourse states pay higher mortgage rates to compensate for the increased risk to the bank.  Therefore, one could argue that those folks paid in advance for the right to walk away from their mortgage.

moneymutt's picture

how much higher...please...if you consider the percentage of people that strategically walk on mortgages, thus could be ripe for collections, and figure how much the banks can get from them after the legal wrangling and chance people simply file bankruptcy etc...the differences in losses in non recourse and recourse states is not that big.

Got evidence otherwise?

...I live in MN, we have pretty decent consumer protections on mortgages...and I refi'd my house last Dec for 4.5 percent interest rate ....I was consistently quoted mortgage rates that were very comparable to national averages at the I was not competitvely hurt by the consumer protections but would be immensely helped by these protections should I lose my job etc....

Banksters train you to worry about them, not syndrome