Mike reiterates a point I’ve been trying to make: taking out a no money down mortgage when you have no job, no credit and no assets is not personally irresponsible, it is (or should be) common sense.
You started out with nothing. The worst you can end up with is nothing. This is basically a no loose proposition. And, you could possibly win if the housing market moves in your favor. In the mean time you also get a sweet pad.
This basic asymmetry in leveraged investment is at the heart of financial crises and I believe recessions in general. If the investment goes well, you win. If it goes bad, the creditor looses. You can see how the incentives stack up here.
I think Mike overstates the case, however, when he says
Now imagine that I’m a degenerate crackhead who took out a subprime loan to move next door to you, in an arrangement that I’m likely not going to pay off. I might not even make one payment. If I default you’ll lose 10% of the value of your home from the externality effect. Assuming your home is worth $300,000, there’s a 20% chance I default in 2 years (realistic numbers), and you lose 10%; 300,000*.2*.1 = I’ve just robbed you for $6,000
Not quite. Chances are I am not going to be selling my home during this period and even if I had planned to, I can wait. Thus, I am probably not going to realize that $6,000 loss.
I do loose something though and this is important; I loose option value. I loose the option to sell my home for 300K. Of course this means I will be stuck in my home for longer than I might of hoped, but it also means more. The sell option on my home is negotiable. I can use it to obtain a lower interest rate of a home equity loan.
In short, if I give the bank the right to sell my home and collect what was previously my equity I can negotiate a lower interest and more credit. Those things do have value. It also why home prices matter to the economy.