Tuesday, January 12, 2010

The mainstreaming of strategic defaults is the best thing to happen to deadbeat speculators since liar loans

I say this because strategic defaults, taken with liar loans (or in other words, the lowering of mortgage underwriting standards) has largely democratized what has always been a Wall Street playground - asset speculation.

Taken in context, what this has done is to enable the unwashed masses to buy what is essentially a put option on the housing market. With minimal down payment ( and at leverage ratios that would that would make Gordon Gekko proud) they gained the rights to all potential gains from an appreciating market, but retain the right to return the keys to the creditors in the event of a fall in market price. Thus, with the current housing price collapse, their option to sell property is largely ‘out of the money ‘ and while they still have the right but no obligation to exercise it, the ‘rational thing’ to do is to, in effect, let the option expire (by walking away).

Then, the current play will be to short the creditor banks, the bond funds heavily invested in mortgages, Fannie, Freddie, the Fed……...Anybody and everybody mortgage assets-heavy, and liable to get just pennies on the dollar, if at all, will be fair game.

After this, what do you think will be the best, most ‘rational ‘ move of these deadbeat speculators? At least those who do walk away with still some money left with them? That’s right, taking after the example of Wall Street, they will now come to realize that they have created the condition whereby they can cherry pick the market for the bargains of their lifetime. Meantime, the last person holding on to his existing mortgage while the market escalates towards Armageddon will be the biggest schmuck.

So if you were unfortunate enough not to have been one of those who sold early while the market bubble was still inflated, you will still have your chance to reap wild gains. Take heed, the seeds of strategic default are now being planted by the most respected academics and thinkers. So come drink the cup of Kool Aid with them, and go ahead, just walk away from your mortgage.

Roger Lowenstein: No one says defaulting on a contract is pretty or that, in a perfectly functioning society, defaults would be the rule. But to put the onus for restraint on ordinary homeowners seems rather strange.

Henry Blodget: One advantage of this move, aside from saving underwater homeowners from pouring money down a rat hole, is that it will help fix the housing market faster. If underwater homeowners walk away, the banks will be forced to take a writedown on the bad loan instead of pretending that it's worth what they say it's worth.

Felix Salmon: If there’s less shame attached to default, we will end up with exactly what we want — less badly-underwritten credit, a more solvent society, and much less tail risk. We went far too many years believing without really analyzing the proposition that credit is nearly always a Good Thing.

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