New data on mortgage defaults reveals that wealthy homeowners are more likely than the rest of the population to walk away from a mortgage loan that is worth more than the property or that they simply can't afford to pay -- it's not just Chamillionaire anymore!
The term of art for this move is "strategic default" and it's been widely debated as an appropriate course of action for borrowers who find themselves in an untenable loan. While a foreclosure can be economically damaging, it may be cheaper than continuing to pay for an inflated asset if the home is "underwater" -- worth less than its mortgage -- or the payments on the property are more than they can afford. Critics -- particularly conservatives like Megan McArdle, who find such borrowers "morally appalling" -- have argued that it is unethical to walk away from a contract, even if it may be in the borrower's financial interest.
The CoreLogic data suggest that the rich do not seem to have concerns about the civic good uppermost in their mind, especially when it comes to investment and second homes. Nor do they appear to be particularly worried about being sued by their lender or frozen out of future loans by Fannie Mae, possible consequences of default. ...“They may be less susceptible to the shame and fear-mongering used by the government and the mortgage banking industry to keep underwater homeowners from acting in their financial best interest,” Mr. White said.
This is the problem with relying on cultural norms to get people to buy into a system that, in this case, values social interests over private interest. Norms of repaying debt are important to making sure credit costs stay low for everyone. But we also live in a world where a big universe of people have recently been able to purchase financial products that were underwritten poorly, if at all, and marketed deceptively, if not with predatory intent. Many people purchased these products not just out of greed -- which is only, apparently, a virtue for the wealthy -- but because they were told they could afford it and had reason to believe such an assertion was correct. When the bottom fell out of the housing market, many folks found themselves owing as much as 40 percent more than their homes were worth, or seeing their interest payments get jacked up in the middle of a recession.
At this point, we should have an equitable fix for this solution, starting with bankruptcy reform that includes judicial modification of home loans, alongside a national standard for mortgage modification that is actually enforced by the government so there can be shared sacrifice for everyone complicit in the bubble: borrowers, lenders, and investors, all of whom participated in the irrational exuberance.
Instead, we have a system where lower-income folks don't have the resources or the knowledge to walk away from their loans or access to a mechanism to equitably adjust their contracts. At the same time, the wealthy can simply walk away from their loans, which protects them economically -- the rich get richer -- while spreading the costs of default on the housing market at large.
While castigating the wealthy and the poor alike for this kind of behavior might reinforce the norm of repayment, it's clear that the function of this rule is contingent on available resources. That's why so much of the moral judgment around walking away from contracts rings so hollowly to my ears -- without structural changes, and especially government intervention, there will always be a double standard. Criticize the people who walk away if you must, but only when you stand against the structures that make it possible.
-- Tim Fernholz
