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Will Strategic Defaults Grow More Common in 2012?

by Chicago Agent

Defaults could rise in 2012, but they could be strategic in nature.

Nearly half of lenders expect strategic defaults to increase from 2011 to 2012, according to a quarterly survey by FICO.

The survey, which sought opinions from 262 risk managers across the U.S., found that 46 percent of respondents expected strategic default volume to increase in 2012, what with 25 percent of American homeowners owing more in their mortgages than their homes are worth.

In addition, just 29 percent responded that the present generation of homeowners consider their mortgage as their most important credit obligation.

Dr. Andrew Jennings, the chief analytics officer at FICO and head of FICO Labs, said that latter statistic is an outgrowth of the economic recession.

“After five years of a brutal housing market, many people now view their homes more objectively and with less sentimentality,” Jennings said. “Regardless of legal or ethical issues around strategic defaults, lenders must account for this risk when they evaluate mortgage applications in declining markets. Many homeowners who find themselves upside down on mortgages in the future are likely to consider strategic default as an acceptable exit strategy.”

The recent trends in strategic defaults do support Jennings hypothesis. According to a survey conducted by Paola Spienza and Luigi Zingales, two Chicagoland professors of finance, roughly three out of 10 mortgage defaults in 2010 were of the strategic bend, which was a 22 percent increase from 2009.

And as we reported at the time, that increase has accompanied a growing social movement advocating strategic defaults as a necessary reaction to the housing crisis, an attitude that some lawmakers have been none too pleased about.

Strategic housing decisions have also been on the mind of Ed DeMarco, the acting director of the FHFA, in his long-standing opposition to principal reductions. DeMarco, a decidedly conservative presence in the housing policy scene, has argued that offering such a policy would incentivize some homeowners to become delinquent on their loans to qualify for a reduction.

Despite the considerable worries abou strategic defaults, FICO’s survey did have some undeniably positive results. 26 percent of respondents expected delinquencies to decline in the coming months (the highest level in two years), and 53 percent said the housing market would improve by the end of 2012.

Jennings said that other economic factors will play a big role in how the housing market progresses in 2012.

“Lenders seem to believe the housing market is starting to stabilize,” Jennings said. “Defaults, whether strategic or not, continue to be problematic. However, a gradually improving job market could begin changing the dynamics in housing. If job creation continues, banks will be more likely to embrace mortgage lending once again. A healthy job market is essential for improving the quality of mortgage applications and reducing default risk.”

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