The crisis in California is going to get much worse, and there is no bailout that will solve it. Why? Because if the first stage of the foreclosure crisis was about people who could not afford their mortgages, the next stage will be about people who have every reason not even to try to pay their mortgages.
Gimein thinks that prime-mortgaged houses are going to tank so badly many people will start viewing them as walkaways. And, despite preachiness, they’re doing the right thing:
Over the next several months, we're going to be subjected to a chorus of hand-wringing about the moral turpitude of people who walk away from their mortgages and pronouncements like last month's warning from Treasury Secretary Henry Paulson that people should honor their mortgage obligations. The problem with finger-wagging on what you "should" or "ought" to do is that, when it comes to money, you're usually given the lecture only when it's in your interest to do the opposite.
And, yes, it’s that bad in La-La Land. Here’s asking prices on some foreclosures Gimein found:
• In San Bernardino, a house bought for $310,000 in 2005 is now being offered by the bank for $199,900.
• A 2,000-square-foot ranch house in Rancho Santa Margarita is down from $775,000 to $565,000.
• A starter home in Sacramento, sold for $215,000 in 2004, is now down to $129,900.
Now, what does this have to do with prime mortgages?
Gimein notes that many prime borrowers got the prime equivalent of a 2/28 and will also be facing resets. These loans, such as option ARMs, he says, normally hit reset points at about four and a half years. In other words, a lot of prime loans from 2003-04 will be resetting in the next year. And, with the housing drop in California, a lot of prime, as well as subprime, borrowers will be underwater. The average post-reset payment will be almost double the pre-reset amount, Gimein says.
And, California is ground zero for this.
Just two banks, Washington Mutual and Countrywide, wrote more than $300 billion worth of option ARMs in the three years from 2005 to 2007, concentrated in California. Others — IndyMac, Golden West (the creator of the option ARM, and now a part of Wachovia) — wrote many billions more. The really amazing thing is that the meltdown in California is already happening and virtually none of these loans have yet reset.
Gimein says that, looking at the current version of the subprime bailout plan wending its way through Congress, that if California prime housing prices drop 40-60 percent, there will be no way to craft a prime-option mortgage bailout plan that is even close to “fair” for both lenders and borrowers.
Gimein notes that, especially if you’re on an original mortgage and not a refi, you could be lucky:
The luckiest of those are the ones who used option ARMs to buy a house. For them, walking away is easy: Their loans are "nonrecourse," and the lenders can't go after them for more than the value of the house. The choice is harder for those who used the loans to refinance. The quirks of real-estate law regarding refi loans make it possible (though not necessarily easy) for lenders to try to get back more money even after taking the house.
Of course, a bunch of walkaways will depress the market even further, and incite more anger among people stuck with refis.
And that, my friends, is why Henry Paulson is wagging his finger at the bidding of his old financial sector buddies.
As for “killing” your credit rating by walking away? Gimein says we used to have the same fears over credit cards, and look at today. In other words, if somebody wants to sell you a house, they will.
So, walk away. And let the moral squabbling begin.
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