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.