Market Update: A personal story reflecting the lunacy of the banking mess

Our family home is on the market. Not unusual that someone sells their home, but our reasons reflect an increasing growing trend among individuals: selling because the incentives are just way too enticing. Here’s the skinny…

In economics, the simplest rule is that individuals react to incentives, like a tax break, or disincentives, like a tax increase. People will shift behaviors accordingly, and done on a mass level, this creates a national or international economy. Simple enough.

Our home was once worth well over $3 million—ridiculous by any standards, but people paid that much for comparable homes on our street. Meanwhile, lenders, until two years ago, would lend up to 95% of the value of a home without need for verification of income– Just good credit and an appraisal. Seems so silly now, but that’s the way it was.

Our home sits directly on a seismic fault. Not near one, mind you. Right on top of one! We decided long ago, that keeping any equity in our home made no sense, since a big quake would likely level our home, and we would lose the option to simply hand the home back to the lender. Accordingly, we always borrowed the maximum allowable and put the funds into the stock market. Great strategy…until it was not.

Fast forward to 2008, when we realized that we owed way more on our home than it was worth, since home prices had begun to decline. No issue, as values rise and fall. We could wait it out. We had gigantic payments, but that was the deal we signed up for—big mortgage, big payments, and ideally, the big stock portfolio on the side.

Not long ago, we looked at the immediate reality, and responded to the incentives available. Our payments equated to “rent” since our home is now worth well less than $2 million, and we owe way more than $2 million. Until such time as we have equity in the home, we are essentially renting it. The payments are enough to choke a horse, and it will take a very long time to have any equity in the property, probably years and years. Our plan for a while was to downsize once our two high school seniors headed off to college, as the “big house” was no longer needed as much as when boatloads of kids hung around the abode.

Meanwhile, we can sell the property at a “short sale” where the bank agrees to forgive all the debt against the property, with an offer “short” of what is owed. Seems like a great deal, and here’s the kicker: it takes a year for the disorganized banks to make a transaction like this happen. During that time, we have no house payments, but full use of the house!

Could a deal like this really be available? If so, why would anyone not take it—that is, respond to the incentives, as it were? But wait. Like a cheesy TV infomercial, there’s more. The federal government passed a bill stating that any debt relief on your personal residence is non-taxable. That is to say, the money we borrowed and put into the stock market, which we will no longer pay back, is non-taxable. This deal just keeps getting better all the time!

So let’s add this up. We borrowed (and borrowed, and borrowed) against the value of our home, put the cash into the stock market, then we hand the upside down property back to the bank, after skipping a year’s worth of payments, and we get to keep the stock portfolio without paying taxes on the money borrowed against the home?

Hmm…ever wonder why we have a budget deficit?

Now, before you come to my home and insist on a tax refund directly from me, there is a dark side to the story. Our stock portfolio has essentially vanished, due in large part to the horrible markets in fall of 2008, so we’re not walking out with much cash. My guess is that no one will shed too many tears, and if we still had the portfolio, we would most likely not walk.

Still, the response to incentives put out by the banks and the federal government seems to insure that the banks will continue to take huge losses and keep us in a weakened financial state for a while, since foreclosure filings are still on the rise.

In the end, people are smart enough to figure out how to respond to incentives, and that result is not great for our country.