Down the Up Escalator

by Barbara Garson

  “She didn’t know until I called her,” Zita says, confirming that part.

  “But as soon as the FDIC took over, they called her right back,” Korina recalls.

  “I didn’t know it was the FDIC thing that turned it around,” Zita says. “I just remember four or six months later putting the fixtures back in.”

  The pieces almost fit together now. Everyone was surprised on the day that a foreclosure notice landed on the door, and everyone participated in ripping out fixtures and putting them back months later. It’s just that some people were focused on saving the house, while some, or at least one, were focused on saving the term’s work. Zita moved out shortly before her mother’s deus ex machina, Sheila Bair, descended to take charge.

  Sheila Bair is widely credited with preventing pre-crash bank runs by operating insolvent banks with a minimum of disruption as she applied standard resolution procedures to balance the interests of depositors, borrowers, and investors.

  But before the crash the FDIC’s authority to “resolve” failing banks didn’t extend to bank holding companies like Citi or to various uninsured, unregulated, nonbank financial institutions that were in trouble. The post-crash Dodd-Frank financial reform bill is supposed to give the FDIC wider authority the next time.

  Even before those reforms, however, many of the FDIC’s time-tested procedures could have been applied to the rescued institutions. Those standard resolution procedures usually begin with taking control away, at least temporarily, from the existing management. Resolutions also usually involve some losses to bank bondholders.

  But both the Bush and the Obama administrations abandoned the traditional resolution approach in favor of simply handing $700 billion to the existing managements of financial institutions deemed too big to fail. I wonder what today’s political and economic environment would be like if our government had conducted its rescue in the spirit of a resolution rather than a bailout.

  Save Your Cash, Not Your Credit

  Before I left Burbank, Bibi San Antonio wanted me to understand that when the crisis hit, she’d acted honorably. As soon as she grasped that house prices weren’t coming back up, she contacted her old clients and advised them to stop paying on the mortgages she’d arranged for them.

  “I have told many people, ‘You’d be a fool to keep paying the $200,000 on a house worth $70,000. If you want to live, walk away. Walk away from it!’ ”

  She’d done that herself in Nevada and had been prepared to walk away from the Burbank house if she couldn’t get a deal to her liking.

  “And you’re really not worried about past foreclosures if you have to apply for a new mortgage someday?” I asked Bibi.

  “No.” Her tone says, “Are you some kind of child?” “You know what happened: you explain what happened. You’re applying for something now, and you have the right income now. I can’t be held captive for something like that!”

  “Do you sell your children in order to make the monthly payments?!” Korina interjected. She and her husband had also walked away from a couple of properties after the crash.

  “But most people worry about their credit,” I objected.

  “You only need credit in order to borrow money,” Bibi explained. “It’s better to have money. That’s why I tell all my old clients, ‘Save your cash, not your credit.’ ”

  ————

  A year after I met the San Antonios in Burbank, Zita came to New York for an academic conference. She was a graduate student by then. I asked whether her mom and dad were still living in their trailer.

  “That’s a funny story,” she said, and explained that her parents had come into a chunk of money related to a Las Vegas hotel investment they’d pulled out of before the place was built.

  “I don’t know the exact details,” Zita said, “but when the dust from the lawsuits settled, they received a check for $175,000. So I said”—here Zita becomes the mature adult—“ ‘Mom, why don’t you buy a house in California?—a house to live in?’

  “She looked at me and said, ‘I can buy two houses in Las Vegas.’

  “I said, ‘Mom, please, I don’t want you to die in the desert.’ ”

  In the end the San Antonios bought neither two houses to invest in nor one house to live in. Residential property was still too risky, Bibi judged; no one knew when it would hit bottom. So she put the money into California commercial real estate in the form of a medical building her son-in-law got them into. Zita reported, “It pays them back monthly, like an annuity, Mom told me—about $2,000 a month.”

  So the San Antonios still live in a Las Vegas trailer park—“That $6,000 trailer Dad bought ‘just in case’ is the best investment they ever made,” says their daughter—and they supplement their Social Security and Mr. San Antonio’s pension with returns from a commercial property. If that goes bad, Bibi San Antonio will surely be ready to move, probably just a little bit late, into the next big thing.

  Chapter Eight

  STRATEGIC DEFAULT

  First-Class Scofflaws

  All over California, solid citizens were discussing whether to stop paying their bills. At the time of my visit about 35 percent of California mortgages were “underwater.” Eleven percent of mortgages were seriously delinquent, and many more homeowners were about to stop paying. Since unemployment was also high there—it was 12.4 percent when the national figure was a little over 9 percent—many would soon have little choice. But a shocking number of people with jobs and savings were making calculated decisions about welshing on their debts. In the lending industry that’s called strategic default.

  Bibi San Antonio is an ardent and unusually open champion of that strategy. But you don’t need a formal interview to get in on California’s default debate. Just say the word “mortgage” in a public place, and it turns into a housing seminar.

  On my way back from Burbank, I mentioned the housing crash in the airport waiting area, and a man volunteered that he and his wife had talked it over with their financial planner, and, he said, “We decided to cut our losses.”

  “What about your credit?” asked a well-coiffed woman who was traveling with her grown daughter.

  The man explained that he and his wife didn’t rely on credit for anything but buying a house. They planned to rent, at least until house prices stabilized. He figured that in a few years lenders would look back at this period and say, “Oh, you got caught up in the bubble, never mind.”

  But what the well-coiffed woman really wanted to know was, if she walked away from her current house, would her credit be good enough—right now—to buy the vacant house down the block?

  “She always did like that corner house,” the daughter said, trying to turn it into a joke. “If you buy it,” she teased her mother, “you can finally take down that clothesline that was gonna lower our property value.”

  But the woman was obviously serious and moved to the seat next to me to talk it over.

  She liked the neighborhood; the corner house was $300,000 cheaper than it had been a few years earlier; it was the house she should have bought in the first place; and now it was even painted to her taste—blue with lavender trim. (The neighbor had taken her advice about repainting before moving out so suddenly.)

  The challenge would be to find a mortgage broker with whom she could lay her cards on the table. She needed to find out, in advance, whether she could qualify for a decent mortgage on the corner house if she stopped paying on her old house in the middle of the block. In a way she was trying to accomplish the same thing as government modification programs. They aimed to settle people in houses that were closer to today’s market prices without making them actually move. The lavender-loving woman’s plan was to move a few doors down to a post-boom-priced house.

  Bibi San Antonio was the only Southern California mortgage broker I knew. But a couple of the others who joined our conversation were able to give her some names in her area. All these would-be defaulters and abettors appeared to me to be upper-middle-cla
ss travelers. At least one was flying business class. Clearly, sneaking away from a mortgaged house was no longer something only a shameless scofflaw would contemplate.

  Co-conspirators

  Cindi and Amanda are friends and colleagues whose work involves giving consultations and seminars throughout Northern California. They made time to meet me at Amanda’s Benicia condo at the end of a long business day. Both women were experts at “accessing data,” as Cindi put it, and had just started using that expertise to decide whether to keep paying their respective mortgages.

  “I had already made some money flipping a condo,” Cindi explained. To me the word “flipping” had an illicit connotation that it clearly didn’t have to the two friends. In prerecession California, real estate speculation had been an acceptable middle-class activity.

  In 2006, Cindi put her whole flipping profit—$100,000—into a down payment on a small $475,000 house near the water in Solano County. She loved the place and fondly described her new marble countertops. But the house would now sell for no more than $200,000. “Yes, I’m down over 60 percent,” Cindi confirmed for me. But her minimum mortgage payment was still $2,300 a month.

  Amanda and her husband live out of state, and commuting to her job was getting difficult. In 2006, a California pied-à-terre seemed like a good investment, and Cindi helped Amanda house hunt. At $390,000 this small two-bedroom condo in a well-landscaped development way north of the Bay Area seemed like the best buy they could find. But only three years later, Amanda estimated that she couldn’t get more than $200,000 for it. (Her estimate proved to be $100,000 high.)

  Cindi apologized for urging her friend to make the purchase, but Amanda pooh-poohed her guilt. “Back then, we all thought prices would just keep going up. Don’t you remember?”

  Just a couple of weeks before I met them, Amanda had returned from a trip home to find that the neighbor on the other side of her wall had disappeared, one family below had stopped paying their mortgage, and another one said he would have to stop paying as soon as his low teaser rate expired. To top it off, she saw that she could rent one of the luxury units in the development—“the same layout as this but with dark wood floors”—for $1,100 a month while she was paying $2,300 a month to “own” and building no equity with that payment.

  Amanda could afford to keep making the mortgage payments, she said, but “it makes you feel sick to throw a couple of thousand dollars out the window every month.” But Cindi, who was divorced and living on only one income, would eventually be caught in an “affordability bind,” she said. Her plan had been to stay in the house until she retired, then take the profit and move someplace cheaper. But that hope was gone for good, she recognized, and “I won’t be able to keep making the payments when I retire.”

  “Basically, we have three choices,” Amanda said. “We can hold the property and keep paying more than it will ever be worth again. We can try to negotiate something with our bank around a short sale or a loan modification. Or the third choice is we can let it go to foreclosure, ruin our credit, and walk away.”

  It was time to get serious, so they divided up the research.

  Cindi was checking into government programs. Neither of them was eligible for the Home Affordable Modification Program, or HAMP, she’d discovered. Their houses were too far underwater. But Washington was about to announce new guidelines. She was pretty sure they’d both be above the income limits, but she’d keep on top of it.

  Meanwhile, Amanda was trying to answer the question that bedeviled so many distressed homeowners: Do you help or hurt yourself with the bank if you stop paying? A realtor told her to stop; it was only then that the bank would deal with you. She tried to check that out at a title company.

  “They said, ‘No ethical realtor would ever tell somebody that.’ But they didn’t deny it.”

  Amanda tried to hire the title company to negotiate for her, but it wouldn’t take her money. The representative told her truthfully that her mortgage company, Bank of America, would not negotiate with a third party.

  The blue-and-lavender lady who coveted the corner house didn’t think of herself as a criminal. Still, she was hesitant to ask her default questions directly. Not these two. “If you want to make the best decision, you need all the information you can get,” Cindi said.

  The two friends apologized for having no definitive answers yet, but they’d just started their research, and as they explained, these had been busy weeks of very long workdays. It seemed like the cue for me to leave.

  I was still mildly shocked to hear well-dressed professionals coolly consider default. But I was beginning to realize that white Californians who drive new cars and speak TV announcer English may be poorer than they look. I don’t know exactly what these women earn; it’s enough to make air commuting worthwhile. But apparently, it hadn’t been enough to own middle-class homes in pre-crash California. At least not as I understand home ownership.

  Amanda bought her condo with a $10,000 original payment. Cindi’s mortgage had an interest-only option. Since she usually made that minimum, all-interest payment, she wasn’t building equity.

  In effect, they were renting from the bank with an option to share in the appreciation when their houses were sold. But that option was now worthless. Their houses had been so overpriced that they won’t return to their prerecession values within these women’s lifetimes. These are hard facts, but the two friends were ready to face them squarely and try to come out of it as well as they could.

  Two years later Cindi was still living in her Solano County home. There’d been a shake-up on the job in the meantime, and she’d accepted early retirement. She’d predicted that she wouldn’t be able to make her minimum mortgage payment once she retired. But with interest rates so low, the interest-only option had gone down by $1,200 a month. Since she could afford the payment, since she genuinely liked the house, and since she had to live somewhere, she stayed put for the meantime.

  Amanda had also been affected by the job shake-up. She now works out of Southern California. Shortly after my visit she’d opted for a short sale. She quickly found a customer ready to buy her Benicia condo for the then going price of $100,000. But when she contacted Bank of America, she was told by a clerk that the bank couldn’t start any sorts of negotiations because the mortgage payments were up-to-date. Amanda reluctantly stopped paying. After ten months of refusals and reversals the bank finally approved the short sale, and Amanda moved out with no debt.

  “The bank could have had the same $100,000 without first giving me ten months of free rent,” Amanda said. “Fortunately, the buyer stuck with me.”

  In the course of her research Amanda heard that her bank was even slower about foreclosures than short sales. She realized that she could probably have lived rent-free in her condo for longer if she dropped the short sale and simply waited for a foreclosure. But she and her husband wanted to do as little damage to their credit rating as possible.

  This is how Amanda summed up her experience as a California homeowner: “It cost us about fifty points on our credit rating. That’s less than I thought it would. It also cost us all of $10,000 that we originally put in. And for five years we paid $2,000 a month in mortgage and owners’ fees for a place we could have rented for half that. I would call it an expensive rental.”

  Chapter Nine

  AN UPRIGHT MAN

  Carrots for Bankers

  When housing prices plummeted and people started defaulting, the first reaction after shock was blame. Irresponsible banks had victimized borrowers. No, irresponsible borrowers had victimized banks. (This is still a provocative topic, and we’ll get back to it.)

  But some people said it takes two to make a loan, so forget the blame and let borrowers and lenders share the loss, as would commonly happen with commercial or industrial real estate debt. The traditional way to do that is through a mortgage modification that lowers the principal to something between the new market value and the old mortgage debt. With a modification
, lenders accept a loss, or a “haircut,” as they say in the debt business. In many cases the banks may ultimately collect more that way than they would through foreclosure, while homeowners get to stay in their homes.

  The argument for modifications wasn’t purely humanitarian, however. The housing collapse triggered immediate massive unemployment. California alone lost some 600,000 jobs in the construction, building supplies, real estate, and related financial sectors.

  But new home building couldn’t pick up while millions of foreclosed houses were still coming onto the market. Keeping people in their homes was widely prescribed as a job, not just a housing relief measure.

  So the brand-new Obama administration immediately proposed the Helping Families Save Their Homes Act, one feature of which gave bankruptcy judges the right to lower a homeowner’s mortgage debt as part of a bankruptcy settlement. Bankruptcy judges already have the power to modify mortgages or “smack down” the debt on vacation homes, farms, and yachts. The Obama proposal would have given homeowners the same leverage that those yacht, farm, and vacation home owners have in negotiating mortgage modifications before a bankruptcy judge can impose a smackdown.

  The new president seemed stunned at how easily the banks, then at the height of their disgrace, were able to smack down the smackdown provision. Their lobbying of both parties was overt, venal, illogical, and completely effective. The quick defeat of this widely agreed-upon recovery measure set the pattern. The Obama administration went on, as it would so often, to propose an insufficient, ineffective compromise.

  That’s how we got the Home Affordable Modification Program, or HAMP, a mortgage modification plan that was all carrots, no sticks. Banks would receive bonuses for each successful modification they made. Banks that signed up for HAMP had the obligation to accept and process applications, but whether they then granted a modification was strictly up to them.