My co-blogger expressed sympathy with Megan McArdle’s objections to walking away from your home.
Surowiecki says that strategic defaults "would force lenders to be more responsible in the future" but he doesn’t make it clear that the corollary is "people would find it harder to get a mortgage (and the value of homes would drop)".
The "people don’t default unless they have to" norm allows us all to get much cheaper loans, while letting off those who, well, really have to. Destroying that norm would come at considerable cost: 25-40% minimum downpayments, higher foreclosure risk, higher interest rates, higher fees.
I don’t think that at this moment a massive wave of strategic defaults would be a net positive for economic growth. On the other hand I suspect that altering norms so that strategic default was the baseline would make for a more prosperous society.
First, it takes a heap of Harbinger Triangles to fill an Okun’s gap. That is, to say the economy can afford an enormous number of market distortions if those distortions in turn avoid recession.
Getting stuck in a balance sheet recession destroys enormous amounts of productive capacity and ruins the lives of millions of people. Its fairly high on the “things that are bad list”
Yet, one way to help avoid this is to let people simply walk away from underwater obligations. In addition, there is the practical bonus that this puts heavier losses on the banking sector and the Fed has shown considerable willingness and ingenuity in rescuing banks.
The more of the pain we can dump on the banks the more of the pain we can effectively treat.
This could mean tighter lending and higher mortgage rates. Though that really depends on what happens to government sponsored mortgage finance. However, where banks are really vulnerable is in bubbles. Which means that you create a dynamic where the more eager a borrower is to cash in on rising housing prices, the less eager the bank is to support this.
That’s a dynamic that’s relatively healthy.
Lastly, unlike, homeowners, banks are more likely to attempt to sell the property fast. This means that collapses in housing prices can occur faster. Its likely that this is a good thing on net. As long as housing prices are falling, its difficult for the housing industry to rebound. However, once they hit bottom things are safer and can move forward.
There are more issues to think about but my sense here is that a world of strategic defaults is a more prosperous world.
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Saturday ~ December 17th, 2011 at 4:13 pm
Matt D
“Lastly, unlike, homeowners, banks are more likely to attempt to sell the property fast.”
This assertion needs data to back it up, because in my experience it is the opposite. Banks will sit on overpriced foreclosures stubbornly, and the process of trying to buy one can take several months before the bank will approve after making an offer.
Sunday ~ December 18th, 2011 at 6:38 am
Rick Russell
Indeed, I think banks are very hesitant to sell foreclosed houses because it means a realized capital loss… a loss that, if extended to the rest of the mortgage portfolio, would significantly devalue their assets.
Saturday ~ December 17th, 2011 at 4:43 pm
drannmaria
Interesting that the really, really bad thing that could come about from strategic defaults is that it would make it harder for people to buy homes. Is that really so terrible?
I’ve bought and sold four homes in my life. I sold the last one 12 years ago and now live in a townhouse by the beach in Santa Monica. This does not impress certain people and I do not get the mortgage deduction. As far as I can tell, those are the only drawbacks of not owning a home. I don’t care about impressing people. The deduction one is a little annoying but we try to accommodate in other ways by maxing our 401(k), maximizing business expenses.
The American notion that owning a house is somehow intrinsically good is questionable, especially when, in my neighborhood, it means going a million dollars in debt.
I could come up with a 25% downpayment. I just don’t see a house as a good investment.
Saturday ~ December 17th, 2011 at 6:23 pm
Chuchundra
The thing that I didn’t see mentioned over at Megan’s place (although I may have missed it) is that there needs to be a fairly extreme set of circumstances for strategic default to be a net positive. It’s not something that a lot of people should consider, moral and ethical questions aside.
There are certainly a lot of people these days who are underwater on their mortgage. I probably am, although not by much. But for most people, it’s not that big a deal. Assuming the economy and the housing market rebounds some, most of them will be back on the plus side in a couple years or so.
If you’ve got a $400K mortgage on house worth $350K, as long as you can make the payments, there’s absolutely no reason to mail the keys to the bank unless you absolutely have to move and the lender won’t agree to a short sale.
There are places around the country where people have lost 50% or more of their equity, housing bubble boom towns where every other house has a for sale or foreclosure sign on it. There was a story earlier in the year about a couple living in a town like that in The Inland Empire in California. Both of them were working second jobs to keep up with the payments, killing themselves to keep pouring money down a rat hole with no prospect of being on the positive side for maybe a decade.
But outside of the extreme housing bubble areas: Florida, Arizona, Nevada, California, there’s probably not a lot of potential strategic defaulters out there just waiting to convince themselves that it would be OK.
Sunday ~ December 18th, 2011 at 6:43 am
Rick Russell
> most of them will be back on the plus side in a couple years or so.
Well, that’s the open question, isn’t it? Maybe the price doesn’t recover in two years. Maybe it’s still down in TEN years.
I paid only 10% more for a house in 2010 as I paid for a similar house in 1995.
Sunday ~ December 18th, 2011 at 4:41 pm
Gray, Germany
What if you apply game theory to the problem? WHY should someone who is underwater on his mortgage stay and pay high premiums? What’s to be gained for HIM? When you see it that way, it’s obvious that those who endure that are just suckers for the greater good, and that those who walk away increase their own profit. I really thought that McMegan with her libertarian leanings would understand that.
Sunday ~ December 18th, 2011 at 9:38 pm
bdbd
Isn’t mortgage insurance meant to address some of these issues? I realize mortgage insurance may not be in effect for many of the houses relevant for this discussion, but the instrument exists. Also, most of the homes now underwater are underwater because of the playing out of events after a run of crazy lending practices by lenders. Perhaps bankers could help us avoid an environment in which large numbers of homeowners become strategic about default by lending more sanely in the first place. McArdle’s fretfulness about stringent future lending practices might be better aimed at those recent crazy lending practices.
Monday ~ December 19th, 2011 at 12:18 am
Benny Lava
Yup it is, and that’s why AIG went bust and had to be bought up by the government.
Imagine this scenario: in the future computers do all the driving for cars. Nobody drives anymore and accidents are rare but people still hold insurance. Then one day there is a glitch in the software and every single car on the road crashes. Since insurance is meant to pool risk the insurance company will obviously go bankrupt and few people would, in this scenario, get their payout.
It is my understanding that this is analogous to the situation with mortgage insurance.