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HELOC Defaulters Just Being Strategic, Using Bankruptcy Properly

David Streitfeld wrote the previous story about all these strategic defaults and how un-American they are. The next in his series of shaming people who can’t afford things is this beaut, where he equates bankruptcy to stealing, sort of:

The delinquency rate on home equity loans is higher than all other types of consumer loans, including auto loans, boat loans, personal loans and even bank cards like Visa and MasterCard, according to the American Bankers Association.

Lenders say they are trying to recover some of that money but their success has been limited, in part because so many borrowers threaten bankruptcy and because the value of the homes, the collateral backing the loans, has often disappeared.

The result is one of the paradoxes of the recession: the more money you borrowed, the less likely you will have to pay up.

This seems to elide the fact that a loan is a contract, with responsibility on both sides. The borrower promises to pay or they lose their assets and their and credit rating, and the lender promises to ensure payment or they take a loss. The lenders aren’t forced to lend at gunpoint, they have agency and they make their own decisions.

I also like the term “threaten” bankruptcy, as if it’s a beyond-the-pale option and not the normal procedure for an individual or group actor without the ability to pay. It’s known in the business world as “smart strategy,” but we can’t have that among people.

There’s no question that people went overboard with the HELOCs and the refinancing. There’s also no question that lending agencies at any time could have denied those HELOCs and refis, and chose not to. In fact they encouraged them. With giant billboards and ads. And they made the profits at the time. I’m supposed to feel sorry for lenders with flawed business models based on endless and unsustainable home price appreciation? The American Bankers Association flak in this article says “No one had ever seen a national real estate bubble” and “nobody could have anticipated,” but common sense would dictate that home prices doubling could never end well.

Streitfeld also addresses in one sentence that the lenders – i.e. the big banks – got government bailouts for their trouble, unlike the poor slobs who lost their jobs because of the financial meltdown or saw their home lose half its value, and now can’t repay their loans.

But the most interesting thing here is how the HELOC borrowers learned that they have leverage, in ways that people facing foreclosure don’t.

Finally, they point to their trump card: they say will declare bankruptcy if a settlement is not on favorable terms.

“I am not going to be a slave to the bank,” said Shawn Schlegel, a real estate agent who is in default on a $94,873 home equity loan. His lender obtained a court order garnishing his wages, but that was 18 months ago. Mr. Schlegel, 38, has not heard from the lender since. “The case is sitting stagnant,” he said. “Maybe it will just go away.”

Yes, basically, this would be the practical effect of cramdown, allowing bankruptcy judges to modify the terms of a home mortgage. It gives individuals a fighting chance against the banks, and forces everyone, not just the borrower, to take a haircut.

With foreclosures not set to peak until next year, you’re simply going to see more borrowers use the tools at their disposal. And if they can’t raise the possibility a bankruptcy judge changing the power dynamic with the banks, they’ll walk away from their homes.

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David Dayen

David Dayen