There are many fans of walking away from mortgages these days. Economic and financial pundits are advising homeowners who owe more than their homes are worth to be as businesslike as the foreclosing banks and simply walk away even if they can afford the payments; taking what is called a “strategic default”. Even rappers are getting into it:
Chamillionaire purchased the 7,583 sq-ft. Houston home for around $2 million in 2006. Now he tells TMZ that the house “isn’t worth anything” but that it was still his most expensive mortgage.
Explained Chamillionaire when cornered by TMZ’s camera on a NYC street:
“So I just decided to make a business decision, to let it go, give it back to the bank. I just didn’t feel like it was a good business investment to keep paying that much mortgage for a house that I’m never at.”
Some buyers -maybe many- are far enough underwater and in dire enough straits that walking away is the right move. I don’t want to give any advice to particular homeowners, but rather make a general plea against walking away to the pundit class who has been advocating it as a good and just choice.
My concern is that there is an intergenerational unfairness to current homebuyers walking away. Past generations didn’t think of a mortgage like ruthless businessman, but rather felt some moral duty towards repayment. This made lending to homebuyers less risky, and thus kept interest rates down. Current homeowners benefitted from these lower rates, and therefore received a transfer of wealth from past generations. If the current generation abandons those social mores against strategic foreclosure and begins walking away from their mortgages en masse, then future generations will have to pay higher interest rates.
This is akin to a time inconsistency problem where past generations have committed to a dynamically efficient regime that is beneficial for all generations but not statically optimal for them, and the current generations is going to toss aside the dynamically optimal regime for their own static benefit. I suspect Chamillionaire has not considered this.
My question is this: are we bequeathing more or less to future generations than was bequeathed to us? I worry that along with global warming and long-term debt this is one more way that current generations are cashing out at the expense of future generations.
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Tuesday ~ June 8th, 2010 at 9:04 am
Rebecca Burlingame
There are important reasons why homes bought in the circumstances of the housing boom do not feel like true personal responsibility. I’m not saying this gives anyone the moral right to walk away. Rather, people need options for creating and choosing housing that are tied to their own individual abilities, drive and motivation, rather than only being able to “buy in” to what is invariably tied to stock markets and mortgage interest rates. The fact that housing in the first part of the 21st century was little more than a money machine is what prevents this sort of housing option from feeling real to a lot of people.
Tuesday ~ June 8th, 2010 at 11:34 am
The Moral Responsibility of Homeowners is to Maximize Expected Utility « Modeled Behavior
[...] ~ June 8th, 2010 in Economics | by Karl Smith One of my co-bloggers argues My concern is that there is an intergenerational unfairness to current homebuyers walking away. [...]
Tuesday ~ June 8th, 2010 at 12:02 pm
Rebecca Burlingame
There does seem to be an intergenerational unfairness in a larger sense, and that is the breaking of trust itself. Breaking trust for economic interaction does often undermine economic activity in ways that are hard to overcome at local levels.
On the other hand, the next generation may actually be the beneficiary of lower home prices overall, as well as a realization that home choices have been too extravagant for some time. Perhaps our grandchildren might actually gain reasonably sized homes they can afford.
Tuesday ~ June 8th, 2010 at 10:43 pm
Lord
If only our financiers and the rest of the mortgage industry felt a moral duty not to perpetrate this and returned their ill gotten bonuses. Don’t see much likelihood of that.
No, there is no intergeneration transfer because interest rates become capitalized into prices, so anyone selling already benefited from any lower rates, just as higher rates will capitalize into lower prices.
Wednesday ~ June 9th, 2010 at 7:42 am
Are foreclosures harming future generations? « Modeled Behavior
[...] ~ June 9th, 2010 in Economics | by Adam Ozimek Karl pushes back against my post on the social costs of strategic default. He offers several points worth addressing, the first of [...]