Strategy and Speed - Default and Bankrupcty - Will you be left behind?

Last week I wrote a post on why strategically defaulting on your home loan may be an economically sound choice, not just for the homeowner but for the overall economy.  Homeowners can deleverage underwater properties through a strategic default and nonjudicial foreclosure and in some cases erase second mortgage debt through a bankruptcy.  Sometimes, the default is enough to create hardship so that an otherwise errant short sale can be pushed through which may also eliminate debt from the second mortgage.

In today's Seattle Times, and really, it was kyped from the AP, a story discussed Borders filing chapter 11 bankruptcy because it couldn't keep up with its market.  One of the quotes really caught my eye, "Less nimble than rival Barnes & Noble, Borders now begins what analysts expect will be a quickly resolved struggle for the survival of its remaining stores."

The lead up to that quote came in the form of Borders missing the fact that its customer base was moving on to other providers for its goods.  Internet retailers, downloads, other big box stores that have driven down prices, and the such.  Really, customers that had evaluated the opportunity costs of staying with a financially bad model or moving onto a better model.   It made me think about some of my clients and really, my potential clients.  Are you going to let the wave of foreclosures wash over you, drive your house value farther into the floor, and leave you struggling to float for the survival of your remaining financial stores?

Many of us don't want to have this conversation, we bury our heads in the sand, hope Obama will wave a magic wand and our housing problems will go away.  If you are among those that are thinking that way I want to shatter that pair of rosy glasses on the bridge of your nose.  Obama can't fix it, it wasn't his fault, and it is unlikely that we will see the necessary tools provided by congress in the near term.  So, as a pragmatist, I suggest we look at the tools we have and strategically plan for the deleveraging of these toxic assets.

Strategic Default gives you as an individual leverage.  Bet you never thought that a deadbeat would have leverage, but many times we don't see the relationship between the layman and the bank in the context of the bank being without money.  The truth is, that if everyone would go to the bank tomorrow, withdraw every penny they have, and then not pay a cent on their loans, the banking industry would be gone in a month.  The banks would all file bankruptcy and disappear.  I am not advocating that, but from one of my favorite childhood movies, remember "It's A Wonderful Life" with Jimmy Stewart, that it was set against the backdrop of Jimmy running a bank in which the customers made a run on the bank and if it weren't for his honeymoon savings, the bank would have been sunk.  The moral of the cautionary tale of the runs on the banks from times past is that the customers have the power because they actually have the money.

The more people that go into default, the more likely that congress is going to finally come together and make decisions that will help stem the tide.  The problem is that many times the corporate donations mean that the legislators fall on the side of favors rather than the consumer and the rules are not likely to fall in the defaulter's favor.  So in the vein of our Borders example above, failure to adapt early to the changing economy is to risk the possibility that the market will pass you by and leave you struggling to float for the survival of your remaining financial stores.

The moral of this is not so profound as the common man holding power over the mighty banks.  It is simply don't procrastinate.  You need to make all speed in understanding this changing housing market and deleverage that toxic, underwater asset before it sinks you in the wave.

Strategic Default...Why its good for the economy?

Our nation tends to be a conglomeration of misshapen lemmings.  We don't all look the same, some are white, some are black, some are tall some are short, skinny and fat, rich and poor, but when something is cool, we like to follow it, like a lemming.  California hit its declines in housing values and its sharp upswing in "negative equity" in 2009.  Well, like the waves I have talked about in previous posts, we see the wave washing over Seattle metro, following California like a great northwestern lemming (which is not as close to extinction as you might expect.)

In the Seattle Times today, the report discussed the rise in "negative equity" going from 23% of all households in teh Greater Seattle area to 34.3% at the end of 2010.  Now, my group and the companies that I have been working with for the last 8 months have been saying that this is the trend for ages now.  We have been talking about how homeowners have seen the greatest decrease in wealth in recent history and now our major news outlet decided to chime in, thank you.

The article quotes Zillow.com's chief economist Stan Humphries as saying, "[the increase in negative equity] increases the likelihood that owners will default - even if they still can manage the payment."  The article then goes on by quoting Glenn Crellin, the director of real estate research at WSU and  states that "strategic default" ..."damages owner's ability to obtain credit for other purchases, further curtailing economic activity."

This article states some generalities but misses the essence of the strategic default.  By definition, it is strategic, meaning there is a plan in place.  Crelin is only half right in his assessment, because what he fails to capture in his analysis or at least in the sound bite  provided by the Times is that by defaulting, the homeowner frees up cash flows of at least the mortgage payment.

Under the Deed of Trust Act for Washington, a defaulting homeowner can expect, at a minimum, seven months of mortgage payments being freed up for use in other economic pursuits.  The cash can be used to get rid of other debt, build bankruptcy proof asset pools, or even on a turn of whimsy pay for that amazing trip that the homeowner and spouse have been dreaming about but never had the cash to afford.

That cash flow is creating economic activity, just not for the banking establishment.  Homeowners are using that cash flow also to maintain lifestyles that have been severly hampered by the down turn in the economy.

The article did note that homeowners that decide to hold onto their mortgage, probably out of an uninformed sense of morality, harm the economy as well.  Those homeowners do not expend money on home improvements, basic maintenance, and are unwilling or unable to move even for better job opportunities.  That means that the utility of the cash being flowed from those homeowners to the banking institutions are actually less effective than that of the strategic defaulter.

Bottom line, it is better to default while you are in control of your financial self, than be forced to default when you have no other options.  Men were created to act, not to be acted upon.