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What to Learn From Florida's Mortgage Meltdown

What is happening in the Sunshine State could spread. And if it does, the financial markets will face another round of intense pressure that could be even tougher to contain than before.
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If anyone wants to see a real live mortgage meltdown in progress, they should visit Florida where, according to the American Securitization Forum, more than 50% of securitized non-agency Florida residential mortgages are greater than 60 days past due.

That means that at least 50% of all borrowers included in the data didn't make their mortgage payments in November and December.

In my world, a 50+ percent non-payment rate qualifies as a bona fide "melt-down".

The Florida 50%+ non-payment pool includes all the mortgages that got sold into the secondary market other than through U.S. government sponsored enterprises, i.e., Freddie Mac, Fannie Mae and Ginnie Mae. According to American Securitization Forum, their data covers approximately 97% of all non-agency residential mortgage backed securities.

The worst types of mortgages were the Alt-A and sub-prime mortgages. Among the 2004 to 2008 vintage mortgages, Alt-A mortgages had a 46.7%+ non-payment rate, while sub-prime mortgage had more than a 63.5%+ non-payment rate.

It's time to confess; I have more than a passing interest in what happens in Florida and not because the "Sunshine State" was named after my family. I live in Florida. The borrowers that aren't paying are my neighbors. Some are my friends.

Why are my neighbors not paying?

I spend a lot of time talking with other Floridians about real estate and mortgages. Frankly, in Florida everyone talks about real estate most of the time. Of all of the conversations, one really stands out.

About six months ago I went scuba diving near my home. My dive group included a bank lawyer, a real estate speculator, a doctor, an accountant and a friend of mine that is a part time dive instructor.

The dive instructor's "real job" is computer programming (being a dive instructor is fun but only pays for the cost of scuba diving). In early 2007, the dive instructor purchased a condominium for approximately $300,000.

Unfortunately, the dive instructor got laid off in 2008. It took him approximately 12 months to find another computer job.

It turns out that the condo had problems. It was built with Chinese drywall and had a leaky roof that caused black mold to grow in the ceiling.

Most of the time the dive instructor was unemployed he didn't make mortgage payments. Given the choice of buying food or paying the mortgage, he chose food. When he got a new job he started paying again.

The dive instructor applied for a mortgage modification. He was approved for a modification three times, only to be told each time that the bank lost his paper work and that he needed to start the process over again. After nine months of making payments pursuant to a temporary modification, the bank turned him down for a permanent modification. When the bank turned him down they tacked onto his mortgage amount penalties, fees and default interest. The bank claimed that the dive instructor owed tens of thousands more than he originally borrowed.

By the time we went diving, the dive instructor's condo was worth a lot less than $100,000. Instead making mortgage payments, the dive instructor again stopped paying and saved the money he was would have been sending to the bank.

The dive instructor was a strategic defaulter.

On the dive boat he told his story and said he was anxious and worried about the future. I watched and listened as the group reacted.

Everyone had the same advice (even the bank lawyer); don't pay and damn the consequences. My fellow divers praised him for saving his money and advised him to be ready for a quick move to a rental unit.

There was no one on the boat who thought that being a strategic defaulter was bad. Everyone agreed the bank got what they had coming to it.

As for wrecking his credit rating, no one thought that it was even worth thinking about. After all, the dive instructor already had a bad credit rating; what's a little more bad really mean. The dive instructor would just join the millions of other Floridians who had bad credit ratings.

Even the accountant agreed that the smart move was not to pay. If he tried to pay, it could take more than a decade until he was able to get right side up in the mortgage. By strategically defaulting, the dive instructor would repair his already damaged credit rating sooner than if he tried to live up to his obligations.

The lawyer and real estate speculator even told the dive instructor that he should immediately file for bankruptcy and cut off the possibility of the bank ever suing him personally for the unpaid mortgage. They argued that the sooner he legally cut off recourse the sooner he would cure his credit bureau.

I asked the dive instructor if he thought about defending the foreclosure. I speculated that the servicer might not have a legal right to foreclose on the unit. The bank lawyer explained that it didn't make a difference if the servicer had the legal right to foreclose or not, they would do whatever it took to seize the condo and the courts would cooperate.

There was a moment where I thought there could be some ugliness on the boat. I wondered if the other divers were going to feed the lawyer to sharks. Banks and their lawyers were the common enemy and the dive instructor was the victim, at least that was how everyone on the boat saw it.

The economy in Florida is bad, but it isn't so bad that more than 50% of the borrowers can't pay. Many Floridians can pay but don't because the system makes it better to default.

More and more Floridians who pay their mortgage feel like chumps compared to defaulters; they turn over their disposable income to the bank and know it will take most of their lifetimes to recover.

As for future access to the banking system, everyone in Florida knows that that banks will be back, offering credit to both defaulters and non-defaulters. The rates maybe a little higher for defaulters but not high enough to make it the smart move to pay. The banks just aren't going to forget about more than 50% of Florida's consumer market.

What's a mortgage meltdown look like?

On the ground it's not so ugly. It's people realizing that they are better off defaulting than paying and that there are few, if any, consequences. It's figuring out that renting is a pretty good option and that neighbors don't really care who is paying and who isn't. Once debtors find personal justification for not paying and get over the anquish of probably filing for bankruptcy life gets a lot better after default.

Florida isn't special. What is happening in the Sunshine State could spread. If it does, the financial markets will face another round of intense pressure. Only this time it may be a lot tougher to contain.