Tuesday, May 4th, 2010 at 11:49pm

Stand With Freddie Mac Against “Strategic Defaults”

Posted by Ron Ballard

Freddie Mac has received a lot of attention lately from short sale investors. Today I write to endorse their position on “strategic defaults” dated May 3, 2010. Freddie’s Executive Vice President Don Bisenius offered “A Perspective on Strategic Defaults” that I commend to every serious investor’s reading at http://bit.ly/9bxSf7

Bisenius cogently discusses this disturbing trend – which reported has even been encouraged by some “financial advisors” (not to be confused with legitimate real estate investors). He identifies “strategic default” when, “borrowers who have the financial means to make monthly mortgage payments, but choose not to do so and, instead, purposely default on their loan.”

Readers who viewed one or more of the webinars about Freddie Mac’s “short payoff fraud” linked elsewhere in this blog heard speculation that Freddie’s earlier statement was largely directed toward strategic defaults and also unanimous condemnation of participating in them. Accordingly, Bisenius’s Perspective is a welcome extension of the earlier news article.

Frankly, I could have gladly written over 80% of the Perspective. Hence, I won’t burden readers with repetition – just read it. Instead, I’ll direct you to some insightful resources about this topic.

The Perspective states, “Indeed, Economy.com, the analytic firm, recently said that more strategic defaults could tip a fragile housing market back into one of further price declines.” Unfortunately, the link doesn’t reach to a specific article and one must be a subscriber to read it anyway. A free trial subscription appears available. I’m guessing the reference is to an April article titled “Strategic Defaults Could Derail Housing Recovery.” Try http://bit.ly/akPK2P to peak at it.

Economy.com also discusses findings of increasing strategic defaults reported by Chicago and Northwestern Business Schools in their Financial Trust Index of April 30, 2010 which states that 31% of mortgage defaults in March 2010 were perceived as strategic. See http://bit.ly/9khC1W . That’s almost one-third of new defaults! No wonder Freddie Mac expresses concern.

For really serious “students” of the topic, one can read a 33 page study discussing moral and ethical issues of strategic defaults at http://bit.ly/9fNd6a .

On April 26 I was speaking at a meeting of short sale investors in Newport Beach and discussed a point about strategic defaults threatening the “social contract” of society and was surprisingly and pleasantly received with a high percentage of agreement. Besides obvious fraud risks, I suggested that investors would be well-advised to avoid involvement with strategic defaults because they are dealing with a borrower who has already decided that contracts need not be honored if not convenient. Could that borrower be trusted to honor their contract with the investor if it becomes inconvenient?

Bob Mittleman of OldSchoolTitle.com, the event sponsor, advised investors to get written permission to obtain the borrowers’ credit report before submission of the short sale application package in order to evaluate the possibility of being entangled in a strategic default. That step has now been added to my checklist of client advice. If you are an investor or real estate agent, I encourage you to add it to yours.

13 Responses to “Stand With Freddie Mac Against “Strategic Defaults””

  1. Becky Mundt says:

    I am sorry but I am going to completely and totally disagree with you. I also contend that this is a position that is convenient for an investor and detrimental to the true well being of a homeowner/borrower, and if that is the case then the investor has lost his/her way. Here is why I say this.

    1. The BANKS overinflated the housing market to gain contracts for overinflated values on ridiculous terms to create his houseing bubble.

    The PEOPLE are left holding the bag for ginormous amounts of ‘mortgage debt’ in comparison to equity/ home value and are told that they are the ones who must bear the burden.

    The INVESTOR comes in and says I will relieve you of your burden at my profit at the lawful proper way of dealing with all of this based on your being financially devestated in this event.


    I say the BANKS are now figuring out that the PEOPLE are figuring out that they are not going into debt slavery willingly or on the BANKS terms and why should they? Because a bunch of bankers, government officials and regulators, ratings agencies and international central banks and speculators all thought it would be a good idea if they DID?


    You have all your moral compasses upside down and backwards here.

    How can you say these things in light of JP Morgan and others dumping MULTI MILLIONS of real estate debt obligation rather than commit financial suicide? So this the moral code of the Freddie’s and Fannie’s and Goldman’s of the world that only the PEOPLE should commit financial suicide? GIve me a serious break.

    This just chaps my hide. As they say.

    Do you NOT dare to collude with the oppressors for the benefit of yourself at the expense of the oppressed.

    At least if you are going to be in this war zone, fight on the right side.

    To protect self intrest at the expense of those taken advantage of is less than honorable.

    To demand that honor be given on ALL sides equally, is honorable.

    This is pure government trype of the tallest order and I am stunned you would fall for it.

    just my .02.

    If the world will be a casino gulag, then the people at least have the option to opt out just as the person corporations do at their choosing. To pretend otherwise is simple pandering to the powers that be.

  2. Ron,

    If a strategic default puts the investor, agent or anyone else ‘working’ with the
    seller in jeopardy or fraud, I would never recommend or move forward with any
    short sale or mod proceedings.

    On an ethical stand point I’ll have to concur with Becky on this one.

    Banks are a privileged industry as they are in ‘bed’ with their government.
    Not just in the US but anywhere. They have figured out that printing money
    at no to low cost on the backs of the taxpayers is much more convenient
    than producing actual work.

    There’s a reason Nixon nixed the gold standard
    “A true gold standard came to fruition in 1900 with the passage of the Gold Standard Act. The gold standard effectively came to an end in 1933 when President Franklin D. Roosevelt outlawed private gold ownership (except for the purposes of jewelery). The Bretton Woods System, enacted in 1946 created a system of fixed exchange rates that allowed governments to sell their gold to the United States treasury at the price of $35/ounce. “The Bretton Woods system ended on August 15, 1971, when President Richard Nixon ended trading of gold at the fixed price of $35/ounce”

    When any organization, individual, household, business or country
    reneges its payment obligations, it’s called bankruptcy. The dutch
    or Brits (forgot who went first) and the French of all countries actually
    sent warships over to new york shortly thereafter (or was it just before)
    to ‘pick up’ their’ dollar equivalent in gold. Then the US said no more
    because they’d run out of gold instantly.

    Luckily for them the US was and still is the biggest military power in full
    force. So who’s gonna go slap their wrist? the UN? gimme a break

    Remember (or learn) that when anyone signs a loan at a bank
    the bank does not actually have the money.
    Try and stay awake reading the Feds own publication on the
    subject of how money is created:

    I have an original printed copy that I found at flee market.

    That’s why matter who’s in the white house, congress or senate
    the only way they have to ‘fix’ the problem is to print more money.
    Bernie Madoff’s empire crumbled, the feds will too but many
    hard working Americans and around the world will suffer first.

    So there is nothing ethical about what the government and banks
    are pulling on the people with mortgages, car loans, student loans
    or credit cards.

    If I were a financial adviser and had a client considering a
    ‘strategic default’ my allegiance would be to the client not
    the bank.

    That doesn’t mean that as an investor I want to get involved
    in these situations. Maybe it’s best the property goes to foreclosure
    good thing is it’s not up to us to decide. We just work with
    the clean deals where seller, agent and lender want to come
    to a viable conclusion of an already bad situation.

    Thanks Ron for the awesome content.

    PS: I wasn’t at the Newport Beach meeting much to my dismay.
    I actually agree with what you write in your paragraph in regards
    to avoiding involvement if there is fraud.
    Now for the convenient part? well is there a risk? sure, but our
    goal is to make it more convenient for the seller, the bank and
    the agents to go through than not.

    PPS: more importantly, I’m sure there was a smart crowd AND
    at the same time I wouldn’t give too much credit to the
    “[I] ..was surprisingly and pleasantly received with a high percentage of agreement”
    from the crowd. Speaking engagements produce more
    bubble head syndrome that all the bubble head dogs and
    celebrity figurines in the back of all the LA cars…

    Anytime I speak to an individual they know there is something
    wrong with this system. They may not know what it is.or how
    it works exactly but there’s something wrong..

    On that note, let’s go help another homeowner.

    Yves Baggi

  3. Ron Ballard says:

    Hi Becky,

    In no way do I support, or even condone, the actions of the lenders and the investment bankers who created the housing and finance crisis and their reactions to continue to protect themselves and even profit from their previous actions.

    The entire problem exists largely due to the underlying process of disconnecting consequences from actions.

    Everyone in the sales cycle of risky loans, including those providing the initial capital, could make lots of money regardless of the eventual failure of the loans. Their ride was only for the reward and not the risk. That is not right in my opinion. Moreover, it is not economically sound because it lacks accountability for decisions.

    However, many borrowers have also benefitted by receiving lots of borrowed money for which they are seeking not to be accountable. I can endorse giving a break to people who have a legitimate hardship. That’s the classic short sale scenario.

    I can’t endorse the wholesale idea that anyone can start choosing to igore what used to be called “the sanctity of contract.” It is truly unfortunate that it appears at this juncture in the musical chairs of finance that many creators of debt designed to fail may get out of this with their profits intact. However, that does not justify similar action by the other willing and profiting participants: the borrowers.

    The borrowers were not “oppressed.” They asked for the money and willingly took it. Many lied to get it. Most “lenders” knew the loans couldn’t be repaid, which is why they sold them.

    The system is broken because there is no standard other than self-interest. I support a market economy, but it is based upon the existence of a common, underlying moral code. Get rid of the code and markets fail and chaos ensues. Sounds like where we are now.

    The securitization of debt was great for “expanding the pool of capital.” It appears to be designed to fail because the people making the lending decisions don’t have a negative consequence for making bad decisions. We see “banks” who approved bad loans “servicing” them for “investors” who bought the notes only to see the “servicers” acting in their own intererst to maximize servicing fees at the expense of investor losses and borrower’s distress. Then the government steps in and subsidizes bad decisions at the expense of all taxpayers — a slim majority of whom likely didn’t have much to do with creating the problem.

    The solution does not lie in continuing to create and endorse systems in which there is no accountability. That will result in chaos and total system break down.

    The solution involves:

    1. Re-establishing the concept of accountability and consequences for choices;
    2. Implementing that consistently in moving forward; and,
    3. Creating and enforcing a system in which those responsible for the “crisis” carry the burden of their actions — not everyone else.

    Admittedly, #3 is the most difficult — and unlikely — of them all.

  4. Ron Ballard says:

    The question came up off-blog: “Is a strategic default fraud?”

    The attorney-like answer: it depends.

    Fraud requires a material misrepresentation (a “lie”) or a material omission that one has a duty to disclose.

    If the borrower is simply telling the note holder, “I don’t like this deal and I want out,” then the borrower is telling the truth and there is no fraud.

    If the borrower is falsifying a hardship by providing falsified records and/or otherwise lying, then there likely is fraud. Legitimate short sale flip investors should not be involved in these cases.

    However, the strictly economic impacts of strategic defaults are the same regardless of the underlying method used to accomplish the result.

  5. Ron Ballard says:

    Hi Yves,

    You said:

    “So there is nothing ethical about what the government and banks
    are pulling on the people with mortgages, car loans, student loans
    or credit cards.”

    And, “Anytime I speak to an individual they know there is something
    wrong with this system. They may not know what it is or how
    it works exactly but there’s something wrong..”

    I agree. The entire financial (and electoral) system needs a radical overhaul that establishes a direct risk-reward system throughout the entire chain of transactions.

    I just don’t see justifying a new “wrong” based on the prior “wrongs” of others. That’s a sure formula for societal chaos and further economic meltdown.


  6. Ron,

    Great reply to Becky’s post, appreciate the clarification.
    It seems now as it was in the past that it is up to the
    ‘little guys’ to keep the big ones accountable.

    All the best

    Yves Baggi

  7. Ron,

    just read your reply to my comment now I guess we were typing at the same time…

    “I just don’t see justifying a new “wrong” based on the prior “wrongs” of others. That’s a sure formula for societal chaos and further economic meltdown.”

    Couldn’t agree more with that. It boils down to deciding if it’s ‘ethical’ or ‘ok’
    to steal from a thief kinda question which every one will have to answer for

    Bottom line though seems to be that our ‘elected’ reps are not acting in
    the ‘represented”s best interests (except Ron Paul as far as I can tell).
    Can’t really blame them as I’m sure most of us ‘regular’ people would
    do just that were we in their shoes and seats ( see Stanford Prison Experiment
    from 1971)

    It’s humbling to become aware that we are molded by our environment
    and the ‘role’ we’re supposed to play.

    Great content Ron, don’t want to keep you on the blog
    too long, go help us help homeowners.

    Yves Baggi


  8. […] a homeowner to default on their mortgage.  My friend and colleague Ron Ballard also has come great insight on this topic on his blog.  And my friends at Old School Title have suggested that investors should start asking for a copy […]

  9. Ron Ballard says:

    If this blog works like I think, you’ll see Justin Lee’s link to 60 Minutes’s Sunday May 9 story on Strategic Defaults. It’s an interesting watch and read.

    This blog is not about political and moral issues, (I have a domain reserved to use for that some day) but about legal issues in connection with short sales, particularly in California.

    From the perspective of real estate investors buying short sale properties (especially for rapid resale) and for real estate agents/brokers involved in these transactions, the key point with strategic defaults remains: don’t get involved in any transaction in which the lack of true hardship is misrepresented (lied about). Then you are risking involvement with a fraudulent transaction.

    If the homeowner is simply telling the bank up front that they are walking away, I think it is unlikely that a short sale will be approved (regardless of any economic sense for the bank/note holder in doing so) and that the property will go to foreclosure and REO.

    This issue needs to be watched in connection with its effects on real estate prices in each particular market so investors don’t find themselves buying legitimate hardship short sales in re-declining markets where it will be difficult to resell, rent or gain any mid-term (2-4 year) appreciation.

  10. Becky Mundt says:

    All I can say to this is that the guy who wrote the piece that tells the WHOLE TRUTH about Don Bisenius and Freddie and this whole mess is MANDELMAN and you should ALL read it – and all I can say is – it hits the nail EXACTLY on the head as far as I am concerned – and his answer to Dr. Bisenius is mine: Go to Hell. Read it here:

  11. Steve Pawera says:

    Hi Ron,

    As I read the comments, it’s clear you have a few fairly inteligent readers. There is certainly a lot to comment on and I don’t want this to turn into a rant. But a few thoughts..

    Judging strategic defaults and the people who may choose them is difficult. I see at least three different basis to judge: the social context (as Bisenius did), the legal context (as you address), and the moral/ethical context (as many people see as the main issue).

    I think it’s important to realize we no longer live in the world of June and Beaver Cleaver. The world has changed. It’s hard to speak of ethics when corporations lay off thousands of workers – and the CEO takes a record bonus for his work. America’s moral compass is largely broken. Tied directly to that, as you said is accountability. I’m hardpressed to think of any problem where at the core there wasn’t a lack of accountability.

    One huge piont Bisenius misses, if you have a strategic default, how about holding the LENDER accoutable? I have to believe most people would not consider a strategic default if they had gotten an acceptable loan mod. Maybe that means a loan mod with principle reduction, but at the end of the day, the LENDER made the decision they would rather have another REO than make a loan mod. Hard to blame the borrower for that decision.

    And as if all this wasn’t enough, Bisenius dares mention the 125% refi? What’s wrong with this program? If you are only underwater by 20% of your loan balance, the government will step in to refi your and minimize the banks exposure by taking the loan of the banks’ hands and passing the loss on to the taxpayer??? I guess at this point, government charity to big business is hardly worth getting upset over.

    But I did take one lesson (a practitioner’s tip?) away from what Bisenius wrote. If the homeowner can find ANY reason, be it work, family hardhsip, health or the dog dying, if they can find a reason they NEED to move, then we can avoid that ugly term of ‘strategic default’ altogether and just call this an ordinary short sale.

    And maybe after the short sale closes, circumstances change and the dying dog gets better?

    Steve (dare I sign my name for this is surely heracy) Pawera

    PS – is there a better place than tagging it on here to start a new topic or throw up an off-topic question?

  12. Ron Ballard says:

    Hi Steve,

    I like to there’s many intelligent readers and commentators here. You’ve certainly added to that with distinguishing the three key way people are looking at this issue.

    To a degree, the “societal” one you mention has an economics element or is the economic one (or a fourth one). From an economic perspective, the eventual outcome to a lender of short sale, loan mod with principal reduction, or a foreclosure to REO all have essentially the same general outcome: a significant loss on the loan which will result in property values working their way to realistically lower levels. There may be tax, regulatory or tactical reasons why a lender chooses one over the other. There are many different incentives or penalties that were designed for other circumstances which now encourage otherwise less than rational outcomes. It’s way to much to get into here. I just don’t have enough time — or complete enough knowledge.

    As to your other topic, feel free to mention it or to email me about it and I might create a post for it.


  13. Steve Pawera says:

    OFF (this blog)TOPIC – but it’s all short sales:

    A lender who reserves the right to the deficiency, obviously has not ‘forgiven’ the debt. There should be no 1099C being issued.

    Conversely, if the lender issues the 1099C, they are reporting to the government that they have paid the borrower income, thereby cancelling the deficient balance, and making any further collection efforts improper.

    If I have all this correct, is it rooted in something more than common sense that I could refer to?


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