What to consider

     There was a great article in the New York Times not a month ago about this very topic (“Just Walk Away” by Roger Lowenstein).  If you’d like a copy, send me an email, and I’ll pass it along to you.  The author’s main point was this:  Big companies don’t hold onto bad assets, feel no shame about unloading them, and don’t worry about their credit ratings.  These companies practice “strategic default.”  Case-in-point, I just recently received an email from a company from which I buy products informing me that it was filing for bankruptcy.  It explains, “As numerous companies have demonstrated during this difficult economic cycle, using this type of legal process can be an effective way of achieving a fast and efficient debt restructuring with minimal disruption to the business.”

     So why should individuals act differently?  Why does the Obama administration ask homeowners to continue paying on their debt on homes in which the debt exceeds the value by 2-to-1?  Because it’s good for the banks, which are selling off their mortgage portfolio to the Fed because it’s a good business decision to unload as many bad assets as possible?  I don’t get it.

     If you decide to walk away from a piece of property and your mortgage obligation, you still have to live with yourself.  If walking away from the debt takes off years of your life in guilt and stress, it’s not worth it.  But if unloading the asset in a time in which banks are prepared to deal with it, why not take advantage of opportunity to put yourself in a better place financially?  Yes, your credit will suffer.  Temporarily. Yes, you will have reneged on a promise.  To this point, I thought the article put it brilliantly:  You did promise to pay, but the contract outlined specific penalties for non-payment.  “The borrower is not escaping the consequences; he’s suffering them.”  I also agree with the author that a flood of “strategic defaults” by homeowners might lead to more loan modifications by banks, which is what’s supposed to be happening.  It might “un-stick” the system, which would be good for all of us.  Consider walking away.  Talk to your accountant, your financial planner, your bank.  Get the facts and then decide.

What does this mean and why do you care?

Warning:  Remember, this is a blog.  The goal here is to present the big picture on sometimes complicated subjects. By design, I oversimplify.

First, it will likely mean higher rates.  Mortgage-backed securities have bond-like quality.  They sell with a price (what they cost) and a yield (what they earn).  The law of supply and demand drives price and yield.  Sorry to haunt you with Economics 101. If prices are high, the yield goes down (which generally drives people to sell).  If prices are low, yield is high (driving people to buy).  If the Fed stops buying those securities and there is no other buyer, prices will drop to attract those buyers, yields will go up as a result, and those yields are directly correlated to mortgage interest rates, which means—you guessed it—that interest rates on mortgages have to go up as well.  Got it?

Second, understand that just a few years ago, the Fed owned no MBSs.  None.  By March, it will own $1.5 trillion.  Trillion with a T.  This means that $1.5T is now in the marketplace.  Too much money in the marketplace can mean greater inflation (too much money chasing the same amount of goods).  Now, so far, we haven’t seen greater inflation.  It’s the Fed’s job to keep that in check.  Someone also has to pay for these purchases, meaning that the American taxpayer is likely going to have to pony up money to cover it.  That may mean higher taxes—higher income taxes, higher capital gains taxes, and the list goes on.

We can’t predict the future, but we can do our best to anticipate what might be coming around the blind curves in the road.  This might be a good time to consider refinancing into that 30-year fixed-rate loan if you haven’t already.  This might be a good time to consider a loan modification.  This might be a good time to consider retirements and education funding plans that provide a tax-free component.