2010 January 25 Monday
Steve Waldman On Strategic Defaults On Mortgages
The bankers who securitize mortages into multiple financial instruments are breaking a sort of social contract.
I think that the moral thing for most borrowers to do, under present circumstances, is to default on loans when it is in their financial interest to do so.
Much of my thinking on economic and social issues comes back to T.S. Elliot’s proposition, “It is impossible to design a system so perfect that no one needs to be good.” Once upon a time, I chose to disagree. I thought it was the challenge of our day, and the grand project of modern economics, to build a system in which people pursuing their own self-interest would provide all social goods, in which the benevolent invisible hand would rule all and we’d have no need to rely upon ideas as shifty and manipulable as “virtue”. I have done a full 180 on this question. Economic self-interest and formal legal frameworks are simply insufficient to regulate a decent society. Elliot was right.
But it’s crucial to remember that “what is moral” is something we collectively decide, and not without constraints. A social order that routinely demands heroic sacrifice of people in the name of virtue will fail. Clever hypocrites will be rewarded while naive saints pay, and the overall tenor of society will not be virtuous. The most we can demand of fuzzy constructs like morality and social norms is what Arnold Kling calls “soft rule utilitarianism”, under which people accept modest personal costs on the theory that if everybody does so, we’ll all better off. But emphasis on the word “modest”, and expectations of reciprocity. Economic and legal scaffolding has to sit beneath informal social constraints so that in general it makes sense to be good. It is like the relationship between flesh and bone: You could not build anything as beautiful as a smile out of bone, but the smile will not survive if the jaw beneath is fractured and misshapen. We regulate the “bone structure” of our society explicitly via legal arrangements, and more subtly, via social and reputational incentives. There’s a kind of hygiene we have to attend to, in order to ensure that doing well and being good are not terribly inconsistent. Over the past few decades we’ve failed to attend to that hygiene, in large part I think because we let simplistic economic ideas persuade us that we didn’t have to, and that the pursuit of wealth yields virtue automatically and dirty is the new clean.
Whatever the reason, we find ourselves disillusioned. People in the financial industry earned huge sums making loans that shouldn’t have been made, offering “affordability products”, Orwellian slang for means of selling homes at unreasonable prices that buyers could not afford. They failed to perform the core social duty of creditors, which is to make prudent judgments about whether loans are likely to be in the mutual interest of borrower and lender over the full term of the debt. Once originators could resell loans, once the financial industry adopted practices of paying cash commissions and bonuses at the time of origination, once we had severed the nexus between the self-interest of the people making lending decisions and the long-term interest of borrowers, it was inevitable that bad loans would be made. So they were. Now that those bad loans are doing what bad loans do, lenders have suddenly found religion, and argue that the moral fabric of our society would be riven if homeowners behaved like, um, bankers. I think that under the circumstances, quite the opposite is true.
Read the whole thing.
I can see another and quite compelling reason for people underwater to walk away from their mortgages: The losses will teach banks not to lend with low down payments and under conditions where housing affordability is low. The US government is determined to shield banks from the full costs of their mistakes. This just creates the conditions for yet another round of folly. Bigger losses by the banks will teach them lessons that they otherwise won't learn.
One can see from this housing price index and another housing price index along with a graph of price-to-rent ratios when a housing bubble is happening. Banks which take taxpayer-guaranteed deposits and gamble with them in housing bubbles need punishment. Strategic default is punishment that'll teach them not to do the same next time - at least for several years anyway.
BTW, big commercial real estate investment corps use strategic default as a business strategy.
Anyone who walks away from a mortgage defaults on the promise he made when he signed the promissory note. What is your promise worth, Randall?
Not exactly, dchamil. A mortgage is a contract that spells out consequences for different actions for various parties. Choosing actions becomes a cost-benefit analysis.
Walking away from an underwater mortgage isn't even bad faith. In fact, under different economic climes, banks have been known to force people to do so.
You linked to three posts with housing indexes. I would not accept the first two, which use an index from the National Association of Realtors, as accurate. The NAR has a terrible record on predicting home prices.
I took a real estate class in college and was taught that you should not buy a home that was more then two and a half times your annual gross income or spend more then 28% of your salary on mortgage payments. Many parts in the interior of the country have prices less then three times median income but much of the coastal areas are still too high using traditional measures of affordability. So the NAR comes up with an index that ignores the price to income ratio and assumes a twenty percent down payment and that current low interest rates will last. How many people in CA do you think have the cash for a twenty percent down payment at current prices?
I think it amusing to read people like Megan McArdle who are greatly upset when individuals walk away from their mortgage but see no problems when corporations do the same. I don't think anyone who thinks that double standard will hold is realistic about human nature.
From the linked interview:
"It’s remarkable that homeownership rates have kept rising even as people’s tenure in jobs has fallen and mobility has grown more valuable. We’ve made homeownership a totem of middle class prosperity. In doing so, we may have, um, foreclosed consideration of a variety of superior arrangements.
I think government subsidy of homeownership is so deeply embedded into our political culture that these policies will expand and persist until some crisis renders them untenable. "
I don't think getting a 30 year loan with a small down payment makes a lot of sense unless you have a very secure job. The importance of homeownership is deeply embedded in our expectations of being a good American. The price of houses in much of the country is still out reach for people at the median income unless they are willing to spend at least twenty hours a week commuting. Politicians should stop pushing cheap credit to solve the dilemma . They should be pushing telecommuting. The technology already exists for a lot of office work and makes financial sense.
How do you walk away from a mortgage in a recourse state?
"How do you walk away from a mortgage in a recourse state?"
If your assets are less then the legal costs why would the bank go to court? I am not a lawyer. Maybe you should go to youwalkaway.com.
The phrase "(select states only)" on youwalkaway.com suggests lenders have recourse in some states if you choose strategic default. I think I would want to know more about the consequences of strategic default in a recourse state before forking over a grand to them.
Do to the bankers what they have done to us, then smoke a cigarette.
What exactly did the bankers do to you if the loaned you the money to put a roof over your head? Where's your responsibility?
If they can opt to strategically default, we should be able to do the same.
What's a healthy financial system worth? Unless banks and the US government face bigger costs for lowering credit standards we are not going to have a healthy financial system.
As it stands now we have Too Big To Fail banks who can cause financial bubbles then lobby to prevent needed regulatory reforms.
I have done a strategic default. I didn't know it was called that! I read my loan documents carefully to see what the consequences would be. Basically, they get the house back and get to keep all of the payments. When reading loan documents, I recommend using a highlighter to highlight the subjects, predicates and verbs of the sentences to help you penetrate the legalese. I lived in the house for three months while the bank went through the foreclosure process. After the foreclosure, I lived in rental property for about five years. It wasn't a problem getting another loan for a house. All I had to do was write a letter to convince the banker that I was an acceptable risk and not likely to default again. It was a one page letter contrasting my financial situation then and now.
The one thing I don't see is how the US Congress can be punished to prevent it from pushing banks to make bad loans to promote "social justice"; citizen outrage hasn't prevented Congress from bailing out the banks with the citizens' money (this time, or the last several times either).
The only healthy financial system for a country is the one in which the majority of its people don't have to become in debt their whole life trying to pay for their house, car, education, health, food, clothes. A healty financial system would allow you to have all that with what you earn, -in a capitalist sytem- in only a few years, not 15, 20, 30 and even longer... But then again the U.S. stopped really being a capitalist country 30-something years ago.
this is not always true because ongoing companies create business plans, project plans, new product plans, and plans for acquiring and integrating other ventures. General Dwight D. Eisenhower once said, “Plans are nothing. Planning is everything.”