You have jingle mail

Anyone who is even thinking about owning U.S. RMBS, or ABS backed in part by RMBS, needs to understand in detail how the underlying mortgages can not pay. In particular, in some U.S. states, mortgagees can simply mail the keys back to the mortgage lender - a practice sometimes known as jingle mail - and walk away without personal bankruptcy. In times of failing house prices, like, err, now, that gives rise to perverse incentives. Consider the following post on brokeroutpost (a site for american mortgage brokers) picked up by Calculated Risk (with the punctuation and spelling mildly edited):

I got an agreement of sale today from a realtor looking for a prequal on a shortsale, the buyer lives next door, he has a current mortgage for $800,000 on a home he purchased in 2005 with no money down, the home he has under contact is right across the street from his present home, the offer is for $500,000 and it looks like the bank will accept it.

The borrower plans to buy it as a primary, once he moves in, they will stop making payments on the $800,000 loan that they have with CW. He qualifies full doc and has a 770 FICO, he figures letting his credit tank is not a big deal when he is lowering his mortgage debt by $300,000 .

I told him the new bank may deny the deal based on occupancy, tried to convince him to go NOO but he does not want the higher rate.

Let's pick this apart. Someone has a house with a 100% mortgage of $800K. The house is worth less. He can move over the road into a $500K (current price) house, and he has a good credit score so he will get a mortgage for the new house. Then he will agree a sale of his current property to the mortgage lender for much less than the loan amount and accept the impact it has on his credit rating.

(A short sale is an arrangement between the current owner of a home and the bank that lent them the money to buy their home to accept an offer for less than the total amount owed to pay off the home. Presumably here the bank would rather get a certain recovery than have the keys in the post and have the uncertainty of what they might be able to realise for the property in due course.)

The comments on this post are fascinating. Firstly it seems that no one, yet, has managed to show that this is actually illegal.

As far as breaking a law, I wish someone would say how, because everyone I have quizzed, replies with a blank stare.

Some people even think it is part of the game:

In my opinion, a mortgage is a contract which allows both parties to walk away from their deal if they don't like what is going on. If the borrower doesn't like the agreement they are in, it is their right walk away. When they do however, the bank has the right to get their collateral. It's just how it is.

It gets better: even knowing the story, some people like the risk.

I will do this loan for .25% less than his best quote.

[...]

I see no reason to walk away from the deal, his present mortgage is not my concern.

And it appears that you can even minimise the impact on your credit rating:

He would not damage his credit if he does it right. He could move into the house across the street and then short sale the house that he owes the larger amount.

Now I don't know how much of this to believe, and I should point out these people are if not estate agents, then pretty close, so I would take a couple of kilos of salt along for the meeting. But still. From the perspective of a security holder supported by the original loan, we appear to see:

• The collateral value is less than the amount we have lent;
  
• There may well be people willing to finance an alternative loan to someone they know is about to default on their previous obligation;
  
• Worst of all, the original lender is going to agree to a loss of principal, perhaps because a bird in the hand is worth two in the bush, but more likely because their foreclosure group is so busy any recovery is worth something given the number of houses they are trying to sell. Which is all very well if it is their loss - but it might well be the ABS holders.
  

Did ABS holders really understand this kind of thing could happen when they bought the securities?