There’s been a lot of discussion recently on the intarwebs about the problem of strategic defaults – homeowners choosing to abandon a mortgage that they could pay because they owe more than the property is worth. The best example is a recent NYTimes piece by Roger Lowenstein, provocatively titled Walk Away From Your Mortgage! Lowenstein argues that consumers are being held to a higher moral standard than banks or other businesses. While businesses routinely walk away from bad deals (and suffer the contractual penalties for doing so – in this case, losing a building or home), consumers have traditionally stayed put. But times are changing:
Such voluntary defaults are a new phenomenon. Time was, Americans would do anything to pay their mortgage — forgo a new car or a vacation, even put a younger family member to work. But the housing collapse left 10.7 million families owing more than their homes are worth. So some of them are making a calculated decision to hang onto their money and let their homes go. Is this irresponsible?
Lowenstein notes a few common arguments against strategic defaults. One concerns the negative externalities – the problems faced by communities when many houses go into foreclosure. But, as Lowenstein notes,
[I]n a market society, since when are people responsible for the economic effects of their actions? Every oil speculator helps to drive up gasoline prices. Every hedge fund that speculated against a bank by purchasing credit-default swaps on its bonds signaled skepticism about the bank’s creditworthiness and helped to make it more costly for the bank to borrow, and thus to issue loans. We are all economic pinballs, insensibly colliding for better or worse.
A second argument that frequently pops up concerns the effect of such a default on the homeowner’s credit rating. And here’s where, to me, things get really interesting. Traditionally, defaulting on your mortgage was a big no-no that could have disastrous effects on your credit for years to come. But, I wonder, should defaulting on your mortgage hurt your credit score? I suppose for the purpose of determining whether or not you can get a nonrecourse loan, it makes sense to want people who are willing to pay off such a loan no matter what. But for other purposes – like determining whether or not to loan someone money to start a business – wouldn’t you rather loan money to the person with enough business sense (“calculative agency”?) to get out of a bad situation? That is, it seems economically rational to default on a mortgage worth far more than the value of the home. So, maybe defaulting on a bad mortgage should raise your credit score!
Ok, maybe that’s a silly idea reflecting my relative ignorance about what credit rating agencies are really trying to rate.
Relatedly, I’d be very curious to know how homeowners were modeled in the various forecasts produced by banks and other financial institutions leading up to the crisis. One of the many assumptions blamed for the current crisis was the belief that home prices always went up. Another assumption, but one that’s received a bit less criticism, was the idea that homeowners would pay on their mortgages if they could find any way to do so. What role did this sociological(!) assumption play in justifying all the practices that led to the current mess?
Last, the Economist blog post linked at this top of the post makes an interesting argument: why should we promote people owning homes so much in the first place?
Finally, I think it’s very difficult to make the case that a world in which it’s harder to buy a house is a world in which we’re all poorer. Houses are dangerous investments—leveraged and undiversified—and they reduce household mobility, which prolongs labour market adjustments. The government has been subsidising homeownership for far too long. The economy could probably stand to evolve to a place where homeowning is not the default, and where the risks of owning are better appreciated.
Should we interpret the rise of the strategic default as an example of people adapting to the new, postindustrial, post-local, whatever you want to call it, economy?