Thursday, April 28, 2011

Is Strategic Default Moral Turpitude?

Strategic default is in the news because it is gaining popularity, and possibly may account for as much as 35% of all mortgage defaults. Strategic default happens when someone who can afford to pay the mortgage decides that it’s not worthwhile to keep doing so, and walks away. This is happening all over the country in situations where the value of homes has dropped substantially below the mortgage amount owed. It’s a daring strategy, not one usually employed by the meek middle classes. Financial writers tut-tut about this practice when individuals do it but strategic defaulters are simply taking a page from the behavior of large corporations. Corporations in our country are beyond feeling shame, but individuals until recently have not been.

Is strategic default an act of moral turpitude? Issues of right and wrong about money are very slippery. Historically, most of our ideas about money have been simple:

Pay cash.
Don’t incur debts, but if you do, pay them back.

That approach to money is now nearly obsolete. It’s in direct contradiction to the way we all have recently been trained to use money. Instead of waiting and saving up for something, we are pressed to buy now and pay later. We have been using capital leverage, i.e., credit, to do this. Just as the concept of paper money only works if everybody agrees that paper money actually is worth goods or services, so also the moral rules of money only work if everybody plays by them. Recently, we have seen egregious examples of companies that arrogantly refuse to be bound by even the most elemental moral rules, or even by regulatory laws. This creates an atmosphere of moral hazard. If the banking system is crooked and yet the banks don't have to pay and no one goes to jail, then why should individuals keep paying? Some people believe the only way to beat a rigged game is to stop playing the sucker. Walk away from a mortgage and the bank gets the house; that's what a secured loan is all about. End of obligation, both financial and moral. Yes, there’s a back-end income tax issue, and in some states the bank can come after you for what’s called the deficiency, but it’s still less hassle than the futile efforts people have been making to pay or modify mortgages they can’t afford.

The real hazard with strategic default is not moral, and it's not that the banks will go broke owning all these houses. It’s that if individuals feel free to act the way corporate crooks do, the entire financial system could grind to a halt. This system does not just depend on the Federal Reserve. It depends on every individual who accepts a paper dollar or a contract as worth something. Most people don’t believe that what they do has such potential for a far-reaching effect. We don’t know at what level strategic or other individual defaults will destroy the U.S. housing market entirely, but maybe we’re on the road to finding out. Meanwhile, the banks are not hurting, not when they seize homes worth $75,000 and sell them to investors for $30,000, while sticking the foreclosed owner with a tax liability for the “forgiven” $94,000 difference still owed on the mortgage. If it’s all a game, say the strategic defaulters, why shouldn’t they play to win?

It is not illegal to default on a mortgage. Right now is probably the best time to use the strategy, when so many others are doing it that one more default won't stand out from the crowd. Sure, your credit score takes a hit, but who says high credit scores are a moral imperative? Only FICO, which is in the business of collecting and selling credit scores, and therefore has a strong interest in making us all care terribly about scores. We have been brainwashed into believing we must behave in a certain way, or we will be punished by the Great God FICO. If substantial numbers of people have lowered scores, then the curve is lower, and who cares? A landlord will rent to someone with a low FICO score rather than let an apartment be vacant. A car dealer will make a deal with someone who has a low FICO score, because the dealer wants to make the sale. And so on.

Would I default on a mortgage? Probably I should have 20 years ago, when the country had a real estate crisis and housing values dropped precipitously. They stayed low for some years, but then they recovered big time. Will this current miserable part of the cycle ever end? I think so, but I hope you enjoy the house you’re living in right now, because rather than strategic default, there’s an even better plan: Just live in your house.

Tuesday, April 12, 2011

Record-keeping Tips

Some people hate record-keeping and others love it, but here’s a dirty little secret: there is no right way or wrong way. Just pick or create the one that suits you best. Here are some popular ones:

1. Shoebox
2. File folder
3. Multiple file folders
4. Expanding file box
5. Ring binder
6. Software program
7. Physical ledger
8. Hybrid

For some of you, record-keeping will consist of throwing receipts in a shoebox. This is perfectly acceptable as long as it doesn’t drive you (or your spouse) crazy. Just don’t attempt to deliver that shoebox to a volunteer tax preparer. And don’t expect that a paid accountant will sort the contents of your shoebox for free. Or in April. Still, if everything is in one place, you have won more than half the battle of record-keeping. Really.

One step up from the shoebox method is the file folder. Same principle: it’s all in one place. Maybe you bothered to sort the items inside the folder into categories; maybe you didn’t. If sorting is not your thing, pay someone else to do it. Again, a tax professional will be pleased to find all your records in one folder, even if jumbled up.

Then there’s the multiple folder method, or the expanding file box method. Of the two, the file box method is best, because it keeps the records in one place. (Notice a theme here?) Multiple file folders have a way of wandering off and becoming invisible just when you need them.

I recently met someone who kept tax records in a three-ring binder. The binder was impressive but incomplete; she had failed to gather all the documents relating to her taxes. One of my co-volunteers complimented her on her record-keeping method, but I was not so inclined. The time she had spent getting the binder, punching the holes, and placing the papers inside would have been better used finding her pertinent documents. The binder made this person look organized, but that was an illusion.

Then there’s the “entering it into a software program” method. Unfortunately, many people I know have been suckered into thinking this is easier than just sorting the actual physical receipts. They usually confess (with surprise) to being behind on entering the data. They have a pile of papers next to their computer, and other piles elsewhere. They are convinced that this is the easiest method, but somehow, they’re never caught up. Record-keeping methods only work if you follow through and use them.

Some people keep ledgers. My mother recorded every single household expense. Reading her old ledgers is like reading the story of my family’s life, since every purchase is entered down to a candy bar. Most of us aren’t that careful. I used to keep a kind of ledger but nowhere near as complete. Mine consisted of two photocopied pages per month with each possible business expense being given a column. After a while I realized that most of the columns were empty most of the year. When I did have entries for them, there wasn’t enough space for the details. Travel was the problem. I didn’t travel often on business, but when I did, of course there were numerous tax deductible events during each trip. My one box per day per category record didn’t work for those. On the plus side, I could see at a glance exactly what my most frequent business expenses were, and adding them up was a mere matter of totaling each column.

I now do a combination method. I keep four file folders, labeled Bills, Tax Deductible, Banking, and Medical. Receipts are tossed into these files as I get them. Every few months, I sort the two biggest and messiest folders, Bills and Tax Deductible. (I never sort the Medical or Banking folders unless there’s a problem requiring research.) Sorting the contents of the folders takes maybe half an hour if I’m really stretching it out. Some other day I enter the items from the Tax Deductible folder into a computer spreadsheet. This takes another half an hour or so, depending on whether I have pre-sorted each category of expense and done it by date. If not, more time is consumed, but not much. This hybrid method works for me. I can be messy with my receipts when that’s my mood. And I can be precise with them when I’m feeling like handling details. I also let the computer do the addition.

Consider whether your current method of record-keeping is a good fit. Are you always losing papers, or behind on entering data, or finding that you have no place to put some category of receipt? These problems can be solved by choosing or creating the right record-keeping method. Just make sure you get a large enough shoebox.