Will walking away from a mortgage go mainstream?

Financial author Roger Lowenstein writes in the New York Times magazine over the weekend:

Time was, Americans would do anything to pay their mortgage — forgo a new car or a vacation, even put a younger family member to work. But the housing collapse left 10.7 million families owing more than their homes are worth. So some of them are making a calculated decision to hang onto their money and let their homes go. Is this irresponsible?

He seems to conclude that it isn’t, and that many more people should be thinking about sending the keys to the bank. He relies in part on the reasoning of Brent White, a University of Arizona law professor who has frequently been quoted advocating that homeowners who are underwater on their mortgages should walk away even if they can afford their payments. Lowenstein writes:

White has argued that the government should stop perpetuating default “scare stories” and, indeed, should encourage borrowers to default when it’s in their economic interest. This would correct a prevailing imbalance: homeowners operate under a “powerful moral constraint” while lenders are busily trying to maximize profits. More important, it might get the system unstuck. If lenders feared an avalanche of strategic defaults, they would have an incentive to renegotiate loan terms. In theory, this could produce a wave of loan modifications — the very goal the Treasury has been pursuing to end the crisis.

Lowenstein, whose best-known works include a biography of Warren Buffett and the chronicling of the fall of hedge fund Long-Term Capital Management, also turns back on the financial industry its own penchant for irresponsibility. Noting that one argument against walking away is that such strategic defaults could drive a new downward spiral in home prices by flooding the market with more abandoned real estate, he writes:

In a market society, since when are people responsible for the economic effects of their actions? Every oil speculator helps to drive up gasoline prices. Every hedge fund that speculated against a bank by purchasing credit-default swaps on its bonds signaled skepticism about the bank’s creditworthiness and helped to make it more costly for the bank to borrow, and thus to issue loans. We are all economic pinballs, insensibly colliding for better or worse.

Felix Salmon at Reuters opines on why a walk-away wave could indeed be building:

It’s clear which way the wind is blowing — and it’s blowing in the direction of continued house-price declines. Houses are still more expensive to buy than to rent, in most of the country, and of course financing is all but impossible to come by, except for that provided by the government, which means that if and when the government prop is taken away, prices are liable to plunge. If that happens, expect a lot more walking away into cheaper rentals than we’re seeing right now, and a whole new vicious cycle of price declines and foreclosures.

— Tom Petruno

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