By all accounts and measures, the foreclosure crisis continues to rage. “Foreclosure filings were reported on 937,840 homes in the three-month period, a 23 percent jump from a year earlier, according to a report real estate firm RealtyTrac.” For many industry analysts, this has come as a complete surprise, as it was expected that the government’s loan modification program would have contributed to an (temporary) abatement. That’s not to say that the efforts of the Obama administration have been in vein; rather, it speaks to a change in the underlying dynamics of foreclosure.

In short, the crisis has entered a new phase. Initially, the majority of foreclosures were driven largely by sub-prime and other risky types of loans. As interest rates rose and housing values plummeted, many of these borrowers suddenly found themselves unable to afford the higher payments and defaulted on their loans. At this stage, foreclosures were largely concentrated in bubble regions of the country, where house prices had appreciated faster than justified by fundamentals. This type of foreclosure has been easy to address, although not as easy to prevent. With the support of lenders, the federal government has sought to modify the mortgages for those struggling with higher debt burden. The underlying principle was pretty straightforward: lower payments should translate into lower default rates.

In the still-emerging second stage, foreclosures have begun to crop up among prime borrowers in relative stable housing markets. This trend is unrelated to risky lending practices, but instead, is a product of the economic downturn and rising unemployment. Job losses have exposed the precariousness of many borrowers’ finances, causing them to begin missing payments almost immediately thereafter. As a result, “About 30% of foreclosures in June involved homes in the top third of local housing values, up from 16% when the foreclosure crisis began three years ago…The bottom one-third of housing markets, by home value, now account for 35% of foreclosures, down from 55% in 2006.”

This brand of foreclosure, while easy to identify, is nearly impossible to treat directly. In many cases, unemployed borrowers can’t afford to make any mortgage payment, which means a loan modification wouldn’t do much to ease the possibility of default. The government is facilitating refinancings for mortgages with negative equity, but for most borrowers, this will only forestall the inevitable. Only when the economy recovers and employers begin hiring again will the crisis subside. While the Mortgage Bankers Association (MBA) is projecting that unemployment will peak at 10% in 2010, many analysts expect that the total number of foreclosures will be roughly the same as in 2009.

Even if new foreclosure filings subside, however, there is still an enormous “shadow inventory” of foreclosed properties that hasn’t yet been brought to market. According to a recent report by Amherst Securities Group, “As many as 7 million pending foreclosures could flood the market in the near future, driving housing prices down. That number represents homes that have already been repossessed by lenders or are in serious danger of defaulting….The 7 million units represent 135 percent worth of an entire year of existing home sales, which are pegged at 5.2 million.” Lenders realize that the housing market is still tenuous to try offload more than a small portion of these properties.
“But some economists expect that a wave of foreclosed properties could hit the market in 2010, dampening home prices again,” as self-imposed moratoriums are canceled.

Many homebuyers smell opportunity, and have waded cautiously into the market. The same goes for speculators, some of which are buying foreclosed properties en masse. Others are buying mortgage notes at deep discounts, as part of a gamble that borrowers will be able to repay them after the crisis eases. “The process works like this: A company or its investors purchase a note, then the homeowners get a knock on their door and are given the news about the change of their loan servicer and offered a modification.” As always, these first-movers could potentially reap large windfalls, Still, given that foreclosures have yet to peak, it might be wise to remain on the sidelines, until all of the dust settles.

According to the most recent data, more than 25% of mortgages are underwater- that is, the balance owed on the mortgage exceeds the value of the home. In the most troubled areas – such as Florida, Nevada, California, and Arizona – this figure can exceed 75%. In addition, negative equity positions can be sizable; one survey showed that the average Miami resident with an underwater mortgage owes about $75,000 more than the value of his mortgage.

In light of these statistics, it’s not surprising that more and more borrowers are simply walking away from their mortgages, despite the fact that many have the financial wherewithal to continue making payments. According to Experian, a credit rating agency, 582,000 such borrowers executed a “strategic foreclosure” in 2008 alone, which is more than twice as high as the 2007 total.

In other words, a growing contingent of borrowers has determined that it’s simply not economical to continue paying their mortgages. (As an aside, this is an excellent indication that homeowners, themselves, don’t have much confidence in the apparent housing recovery that many analysts believe is taking shape). Before, it was assumed that the impact of foreclosure on one’s credit would be enough to discourage strategic default, but the uptick in this trend demonstrates otherwise. Some borrowers evidently think it will be too many years before housing prices will return to the bubble levels. For those that bought properties for speculative purposes, there is a sense that it makes little sense to continue making payments on an investment that has little value.

Despite the clearly negative impact of this phenomenon for lenders, they appear to be doing little to avert it. Some are finally helping borrowers with loan modifications, but this rarely involves a truncation of the principal amount. Thus, borrowers who were underwater before receiving a modification will likely remain underwater after a modification, despite the lower monthly payment.

The government, for its part, hasn’t done much either. Its program aimed at helping underwater borrowers reduce their debt burdens through refinancing has been a miserable failure, reaching only 3% of eligible borrowers, despite the recent elimination of an initial 5% cap on underwater equity. It seems that despite the possibility of a lower interest rates, most borrowers are smart enough to realize that paying money (i.e. closing costs associated with the refinancing) to retain an underwater mortgage doesn’t make financial sense. Ironically, the Mortgage Forgiveness Debt Relief Act of 2007 is facilitating strategic default by allowing borrowers to discharge of debt tax-free. [If not for the law's passage, foreclosure could have potential tax consequences].

Still, there are negative consequences of ignoring government help and deliberately defaulting on a mortgage. For the majority of Americans, foreclosure is still stigmatized. From a financial standpoint, foreclosure (as well as short sales and deeds in lieu of foreclosure) will immediately result in a lower credit rating, diminished ability to borrow, and higher interest rates. Thanks to the Mortgage Forgiveness Debt Relief Act, strategic default no longer carries any tax implications. Of course, they may be costs associated with finding a new residence.

From a legal perspective, one’s liability post-foreclosure depends one’s state of residence. 10 states forbid banks from making claims against personal assets when foreclosing on a mortgage with negative equity. The other states, however, generally allow lenders to sue for the difference. Legal experts have indicated, however, that this is only used in 15% of cases, which means the majority of defaulters get off with hardly a slap on the wrist. Still, if you’re considering this as an option, it would be beneficial to consult a lawyer and/or accountant just to confirm.

While the collapse of the housing market has been viewed universally as a negative development, there is a silver lining: property taxes. All else being equal, lower property valuations translate into lower property taxes. Of course, the reality is much more complex.

Generally, the burden is on the homeowner/taxpayer to prove that the current valuation is inaccurate. Given that housing prices have fallen across-the-board, chances are that many homeowners will find themselves facing such a problem. In most cases, it seems state and local governments are amenable to adjusting the valuation:”Once a petition is filed, the county Value Adjustment Board sets the case for hearing in front of a special magistrate. Should the magistrate rule to reduce the contested tax assessment, owners who have already paid their taxes will receive a refund.”

Other areas are being overwhelmed with appeals and finding it difficult to process them before the tax bills are sent out. For that reason, one jurisdiction is moving to give homeowners the benefit of the doubt: “If their assessed value jumps five-percent or more in a year, the new law shifts the burden to assessors to prove they got it right.”

Some homeowners will see their tax bills fall doubly, both as a result of a lower valuation and lower tax rates. There are stories of local governments that are contemplating lowering property taxes as a type of economic stimulus. And lowering taxes never hurt politically, either. Unfortunately, it appears that lower rates appears to be the exception. Most state and local governments are facing record budget deficits, and are using property taxes to plug the holes. By tweaking rates upward, they can at least compensate for the revenue that would otherwise have been lost to lower valuations.

A new strategy, practiced by governments most desperately in need, is to sell “their delinquent tax bills to the highest bidder….Private investors step in and buy tax liens, paying governments upfront all or part of the value of the taxes. The investors then get the right to foreclose on the properties, taking priority over mortgage lenders, and to charge interest rates as high as 18 percent on the unpaid taxes.” While a win-win scenario for governments and investors, both of whom stand to reap huge cash windfalls, the program can be extremely detrimental to homeowners, which can see their tax bills (as a result of interest) skyrocket.

Unfortunately, there’s no law protecting homeowners in such situations, since the investors function as collection agencies, only going after back-taxes instead of credit card debt. In the end, if you don’t pay your property taxes (whether to the government or to a legally entitled third party) the result is the same as if you didn’t pay your mortgage on time; you lose your house.

Following up on yesterday’s post (Is it better to rent than buy?), today I thought I’d blog about the switch from owning to renting, in practice. In order to solve both the glut in housing supply and the shortage of rental housing, the government is trying to make it easier for “victims” of foreclosure to stay in their current properties as renters, even after they no longer own the respective properties. “The bill would remove legal impediments blocking federally regulated banks from entering into long-term leases – up to five years – with the former owners of foreclosed houses. It would also allow banks to negotiate option-to-purchase agreements permitting former owners to buy back their houses.”

The idea works as follows: after foreclosure proceedings are completed, the previous owners would be given the option of renting the property at a market rate. After a few years of such an arrangement – assuming that all rent payments were made on time – the tenants would then be given the option to purchase the property back. This might seem familiar, and some of you might recognize this arrangement is a tweak of a traditional lease-to-own option, which are usually used to facilitate the purchase of a house, not after foreclosure.

Under current rules, lenders are permitted to rent to the previous owner (or anyone else for that matter), but since the idea is to sell the foreclosed property, lease arrangements are usually only month-to-month, and the owner-turned-tenant can be evicted at any time, once a permanent owner is found. Under the proposed legislation, “The mortgage holder is permitted to resell the house after foreclosure, but any buyer must honor the existing lease. Rents can be increased yearly, according to the Labor Department’s consumer price index for rents in the area.”

Of course, this idea is not without its faults. First of all, there is the notion that if a homeowner cannot afford the mortgage payments on a house, is it reasonable to expect him to be able to make rent payments as a tenant. There are other critics who insist that the legislation has not gone far enough, by giving banks the option – but not the obligation – to rent foreclosed properties back to the previous owners. Finally, there are some who insist that lenders are not suited to being landlords.

This notion is reflected in a variation to this arrangement, under which a third-party investor is introduced into the equation. “First, the bank agrees to a short sale to a private investor, just as they often do now….The investor is contractually bound to lease back the house on a “triple net” basis – the tenants pay taxes, insurance and utilities – for two to three years…The deal comes with a preset buyout price after the leaseback period. That price is higher than the short-sale price paid by the investor, but lower than the original price of the house paid by the foreclosed owners.” Under such an arrangement, everyone should theoretically emerge satisfied – the lender, investor, and homeowner/tenant.

This post represents a follow-up on last week’s report, Underwater Mortgages Increase, but No Break for Borrowers, in which I described the growth in underwater mortgages, a term that describes borrowers whose mortgages exceed the value of their homes. This week witnessed the release of a report with a similar theme: “Almost one-quarter of U.S. mortgage holders owed more than their homes were worth in the second quarter and that figure may rise to as much as 30 percent by mid-2010 as job losses and foreclosures climb, Zillow.com said.

It seems that this phenomenon is destined to turn into a major issue, as two research organizations have now sounded alarm bells within the span of one week. (The seminal report was authored by Deutsche Bank, which warned that, “The percentage of people owing more than their properties are worth may increase to almost half of U.S. mortgage holders before the housing recession ends.”)

This trend could have significant consequences for both the housing market and the economy in general. As unemployment rises, more homeowners are falling behind on their mortgages. One analyst points out, “If you look at prime jumbo, the highest quality mortgages, 6.2% are seriously delinquent. That sounds like a low number. But two years ago that number was 1%. It’s a very straight trajectory from September 2007, pretty closely mimicking unemployment.” Consider also that “In June, foreclosures accounted for 22 percent of total U.S. home sales.”

This will inevitably cause housing prices to trend lower, exacerbating the problem of negative equity. In the same month, “29 percent of homes sold were purchased for less than what the owner originally paid.” In turn, this feeds back into the housing market: “The negative-equity rate will rise and spin off more foreclosures. I see a substantial downside risk to prices and don’t think we’ll see a bottom until the middle of next year.” And the cycle repeats itself.

The main unknown is not whether negative-equity mortgages will become more prevalent (this seems inevitable), but rather the proportion of underwater loans that will result in foreclosure. It is especially difficult to forecast strategic foreclosure [deliberately defaulting on a (underwater) mortgage]: “People say, “I bought my house for $500,000, it’s worth $250,000, there are 10 available for sale in my neighborhood. It makes no economic sense to spend the rest of my life trying to pay off a $500,000 debt when there’s no reasonable likelihood to expect this house to go back up to $500,000.”

Thus, strategic defaults are best estimated/understood as a function of underwater loans. As for the most accurate way to make such an estimation, there are a couple approaches. In an earlier post on this topic, we reported that “26% of the record numbers of home mortgage defaults across the country are strategic.” According to a recent study by The Federal Reserve of Boston, meanwhile, 7% of underwater borrowers in one sample size defaulted. Deutsche Bank, however, believes this is an underestimation: “We do know that most people try to maintain their home. They try to keep their mortgage current. But to expect it to be as low as 7% is very wishful thinking.”

According to a new report by Deutsche Bank, and investment firm, the number of borrowers with underwater mortgages – those who owe more on their mortgage than their homes are worth – is projected to skyrocket in the next few years. This proportion, “will nearly double to 48 percent in 2011 from 26 percent at the end of March, portending another blow to the housing market.”

Deutsche Bank didn’t offer much in the way of context/analysis for its figures, which is somewhat surprising since several indicators of the housing market have begun to tick up. Regardless, the projections are eye-opening, to say the least. Everyone already knows about the problems affecting the riskiest class of mortgages. With regard to subprime loans, “69 percent will be underwater in 2011, up from 50 percent in March, Deutsche said. Of option adjustable-rate mortgages — which cut payments by allowing principal balances to rise — 89 percent will be underwater in 2011, up from 77 percent.”

Those following the housing market probably would have also anticipated that some of the most distressed regional markets would see a rising percentage of underwater mortgages, many of which were no doubt funded using the risky mortgages cited above. For example, “Las Vegas and parts of Florida and California will see 90 percent or more of their loans underwater by 2011.”

Few, however, would have expected such dire predictions for prime loans, which “make up two-thirds of mortgages, and are typically less risky because of stringent requirements.” As a result of a projected 14% price decline up to  41% of prime conforming loans may be characterized by negative equity by 2011. “Forty-six percent of prime jumbo loans will be larger than their properties’ value, up from 29 percent, it said.”

Most troubling, perhaps, is the notion that such borrowers won’t receive a break from lenders, nor from the government. Currently, the practice of reducing one’s mortgage (known as a cram-down) as a result of personal bankruptcy, remains taboo as a result of industry pressure. “House Financial Services Committee chairman Barney Frank (D-Mass.) has already warned that if more loans aren’t worked out, he’ll renew the push to allow bankruptcy judges to order reductions in mortgage amounts.”

In fact, government legislation appears to be moving in the opposite direction. Arizona, for example, is contemplating changing its laws on deficiency judgements, which currently serve to prevent a lender that “forecloses on a home mortgage to recover the balance of what is owed the lender if the foreclosure sale doesn’t produce the full amount…The changes, which haven’t yet taken effect, impose new eligibility requirements to qualify for protection against a deficiency judgment. One is that the borrower must have lived in the property for six consecutive months.” If this takes effect, then borrowers that walk away from their underwater mortgages might see the balance stay with them forever. What’s next – a return to the days of debtor prisons?

The Mortgage Calculator has blogged extensively on the topic of loan modifications, and many of the posts have harped on banks for failing to make the program a success. A couple of recent exposes in the mainstream media, lend additional credence to this notion. It turns out that despite the cash subsidies offered by the government, loan modifications are still less profitable for banks, on average, than the alternatives.

The first alternative is to take no action. Research has showed that a large portion of borrowers (between 1/5 and 1/3 according to two estimates) are able to catch up on their loan payments without help from the lender. Meanwhile, “A second set are those who are likely to fall behind on their payments again even after receiving a modified loan and are likely to lose their homes one way or another. Lenders don’t want to help these borrowers because waiting to foreclose can be costly.”

Another option is to allow the home to slide into foreclosure. Conventional wisdom suggests that foreclosure is never profitable for the bank. What this notion ignores, however, is that the majority of mortgages are packaged and bought by investors, leaving the bank only to service the loans. In such cases, the hit caused by foreclosure is born entirely by the investors, rather than by the originator. As a result, “Even when borrowers stop paying, mortgage companies that service the loans collect fees out of the proceeds when homes are ultimately sold in foreclosure. So the longer borrowers remain delinquent, the greater the opportunities for these mortgage companies to extract revenue — fees for insurance, appraisals, title searches and legal services.”

Then, there are the fees that lenders charge for late payments. “Servicers charge substantial penalty fees when loans are in delinquency or default — a source of revenue that goes away if a homeowner gets back on track.” That delinquent mortgages are extremely profitable is reinforced by the data: “From June 2008 to June 2009, the number of American mortgages that were 90 days or more delinquent soared from 1.8 million to nearly 3 million, according to the realty research company First American Core Logic. During that period, the number of loans that resulted in the bank taking ownership of the home declined to 245,000, from 333,000.”

Despite the federal government’s claim that the loan modification program has been and will continue to be a success, the fact remains that “The latest available figures show that the number of households at risk of foreclosure is 700% higher than the number of loan modifications, and the gap has been increasing steadily.” Until the program is tweaked, such that banks are compelled to increase loan modification volume – through greater incentives and/or stricter punishments – borrowers receiving loan modifications will remain the exception, rather than the rule.

Most of the attention surrounding the foreclosure crisis has focused on homeowners, but perhaps its time to turn the spotlight towards another demographic: “Renters…are overlooked by federal foreclosure prevention programs solely designed to help homeowners. ‘They’re facing many of the same issues as homeowners, but there is not attention on it…They are swept up in the mortgage crisis as well, but they are kind of the unseen victims of it.’ ”

That’s right- many of the properties implicated in the housing crisis are not primary residences, but rather rental properties. “According to the National Low Income Housing Coalition, more than 20 percent of U.S. properties facing foreclosure are rentals, and renters make up about 40 percent of all families facing eviction.” Their owners made the same misguided assumptions about their ability to afford the properties, and lenders were just as happy to provide them with mortgages. Now, many of these owners are finding it difficult to stay current on the mortgages, which has caused some of the properties to slip into foreclosure.

Other properties have been beset by equity stripping, whereby investors used proceeds from cash-out refinancing to pay themselves dividends rather than invest in improving the properties. “Saddled with oversize mortgages, cash-strapped buildings scrimp on basic maintenance. In December, New York Sen. Charles Schumer urged the SEC to investigate, calling the situation subprime crisis 2.0.”

Previously, renters lacked even basic rights when it came to foreclosure. As soon as the lender took over the mortgage, it could legally evict all tenants. On May 20, however, Congress passed the Protecting Tenants at Foreclosure Act. “Renters now must be given at least 90 days to leave. In some cases, renters will get to stay even longer. If the new owner is an investor, the renter can stay until the lease expires. But if the new owner is the lender or the home is sold to someone who wants it as their primary residence, the 90-day rule applies. During the foreclosure process — before a lender takes back the home — renters can stay as long as they have a lease and continue to pay their rent.”

On the surface, this law restores the rights of honest, rent-paying tenants, by giving them time to make new arrangements in the event of foreclosure. At the same time, it doesn’t do anything to solve the problem that rental properties facing foreclosure are caught in a sort of legal limbo, making them undesirable places to live from the standpoint of tenants. “Many banks instead do all they can to avoid taking over, including stalling the foreclosure process so they don’t become owners…Between the time the owner stops paying and the lender actually forecloses _ a process that can take up to a year _ buildings deteriorate rapidly,” said one expert.

Fortunately, many states (already) have their own laws that protect tenants. “Seventeen states require that tenants receive notice when they’ll be evicted due to foreclosure…Twelve states require tenants be named as parties to foreclosure proceedings, in order to terminate tenancies or give the new owner immediate possession rights. In New Jersey and the District of Columbia, a tenant’s lease can outlive a foreclosure, and tenants can continue to rent from the new owner of the property when a foreclosure is finalized _ often the bank.” If you’re a renter living in a home about to be foreclosed, then, you should first begin by familiarizing yourself with state and local laws. If that doesn’t yield fruit, try contacting the constituent services office of your local congressman.

In yesterday’s post, I expounded upon a new trend in the foreclosure crisis – the “strategic default” – whereby underwater borrowers deliberately make a calculated decision to stop making payments on their mortgage. “Current lending practices have created an environment where a measure as extreme as abandoning a home actually makes sense to some people. Many buyers put little or no money down, so they don’t have much invested in them. That leaves them with little incentive to keep making payments when a home’s market value dips below the balance of the mortgage.” With today’s post, I intend to develop this thread further to explain how default (strategic or otherwise) affects one’s credit score.

It turns out that this impact is relatively modest, especially when you compare it to continuing to make payments on a mortgage that well exceeds the value of one’s home. Obviously, borrowers can expect to see their credit rating deteriorate overnight, by a significant margin – as much as 200 points. In addition, it will be nearly impossible for one to take out a new mortgage (or any other significant loans, for that matter) for at least a couple years. The exact duration depends on many factors, namely the borrower’s credit score at the time of default. Ironically, “The higher the score, the greater the damage.”

However, the credit scoring system is such that continuing to make mortgage payments in lieu of payments on other debt instruments (such as credit cards and auto loans) might actually be more detrimental in the long run. ” ‘While a mortgage default can savage a person’s credit record, trying to pay off a loan they can’t afford could be worse for borrowers if it leads to bankruptcy,’ ” said one source. “Credit scores are hurt much more by missing multiple payments – on credit cards, cars and so on – than by a single foreclosure.” In other words, it would take longer for your credit to heal (i.e. a longer wait before you could take out a new mortgage) if you declared bankruptcy, than if you defaulted on your mortgage, even though the Dollar amount of the latter is in most cases much larger than the former.

What about the alternatives? A short sale is now an increasingly attractive option for many borrowers, “thanks to the Mortgage Debt Relief Act of 2007. Previously, if a bank sold a foreclosed home for less than the mortgage balance and it forgave the difference, the borrower had to pay tax on that difference as if it were income. Now the IRS will ignore it.” Even though short sales don’t show up directly on one’s credit report, they are still incorporated into the credit score as a negative event.

The same goes goes for a deed in lieu of foreclosure, in which “the borrower turns over the deed to the property to avoid foreclosure and settle the debt.” While such can help one avoid the delinquent payments normally associated with foreclosure, the deed itself will still show up on the report. According to one source, the logic that one of these choices is better than the other is just plain wrong: ” ‘Someone out there is passing along a rumor that a short sale is better for your credit than a foreclosure or even a deed in lieu of foreclosure,’ he said. ‘All are equal in the eyes of FICO.’ ”

Even loan modification can negatively impact one’s credit. One would think that by preemptively contacting one’s lender (especially before the mortgage becomes delinquent) would receive favorable treatment in the eyes of credit scoring agencies. Unfortunately, their rubrics assume that modified loans are more likely to result in default: “We view an account that has been settled or renegotiated for less than the full amount as a negative because historically consumers on reduced payment plans represent a greater risk,” explained one expert. While loan modifications are generally less punitive than foreclosures, the credit hit can still be significant. It’s no wonder some borrowers are electing to simply walk away.

According to a recent headline-grabbing study, “26% of the record numbers of home mortgage defaults across the country are ‘strategic‘ — that is, calculated economic decisions to bail out of loans by owners who actually have the money to make the payments but can’t handle the negative equity they’re carrying caused by local property value declines.” In most of the coverage to-date surrounding the foreclosure crisis, this class of defaulters has been largely ignored.

The study found that there were a few variable which correlate closely with borrowers’ respective willingness to intentionally default. First, and most obviously, is the value of the mortgage compared to the current value of the home. Specifically, those whose mortgages are most “underwater” are also most willing to default: “Researchers found that almost no homeowners would default if their equity shortfall was less than 10% of their home’s value, but one-in-six homeowners would default if their equity shortfall reached 50% of their home’s value.”

In controlling for age, location, and education level, the study determined that “Well-educated borrowers, homeowners in the Northeast and West, and people under 35 or over 65 were less likely to have moral reservations about choosing to walk away from making mortgage payments.” One’s sense of morality evidently plays a strong role in this calculation, with those who regarded strategic default is immoral 2-3 times less likely to default than their amoral counterparts. This relationship, however, is also proportionate to the size of one’s negative equity position: “While four out of five homeowners said they believed it was morally wrong to intentionally default, as negative equity rises, more borrowers—including those who said strategic defaults were immoral—would consider walking away.”

However, morality (in the case of strategic default at least) is apparently received from social cues. In other words, borrowers surrounded by default were themselves more likely to accept default as an amoral possibility. “The higher the number of foreclosures in a given ZIP Code, the higher owners’ willingness to walk away, the researchers found, suggesting what they call a ‘contagion effect that reduces the social stigma associated with default as defaults become more common.’ ”

This has some important implications for the recent federal legislation, which has aimed to prevent foreclosure by simply helping borrowers to modify their monthly payments, thereby making their mortgages more affordable. However, this legislation is built implicitly on the ideas that underwater borrowers will still repay their mortgages, and that affordability should be measured/enhanced on a monthly – rather than an aggregate – basis. If this report is to be believed, both of these assumptions are questionable. Perhaps this means that we will soon seen a corollary to this legislation passed, in which borrower equity (i.e. mortgage value) is also adjusted. Or maybe not.