Go Ahead, Strategically Default On Your Underwater Mortgage

“Homeowners should be walking away in droves. But they aren’t. And it’s not because the financial costs of foreclosure outweigh the benefits. One can have a good credit rating again–meaning above 660–within two years after a foreclosure.” That’s the conclusion reached by a law professor who’s written a paper about strategic default, which is when you elect to walk away from an underwater mortgage because you stand to lose more money trying to keep it than if you cut your losses immediately. The problem is, lots of people think it’s the wrong thing to do, because individuals are supposed to play by different rules than the companies they do business with.

Over at Metafilter, there’s a lengthy discussion about the paper and the concept of assymetrical norms, which is what it sounds like–one party in a transaction is expected to follow a stricter set of rules than the other, and punished by accusations of immorality or poor ethics–usually by peers–if they don’t. The law professor, Brent T. White of the University of Arizona, says this is why too many homeowners don’t act in their own economic best interests. This is the abstract of his paper, “Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis”:

“Contrary to reports that homeowners are increasingly “walking away” from their mortgages, most homeowners continue to make their payments even when they are significantly underwater. This article suggests that most homeowners do not strategically default as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to induce homeowners to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision. Unlike lenders, individual homeowners have thus generally not acted to minimize their losses and have born a disproportionate share of the burden from the housing collapse.”

The Washington Post talked to White about his argument, specifically to ask how he can say strategically defaulting might be financially healthier for a homeowner. White notes that some states protect a homeowner’s assets from a lender, while in other states a savvy homeowner might be able to find cracks in the mortgage agreement that open loopholes of protection. (A Loophole of Protection will add +5 to a saving throw against a Deed Troll, as you probably know.)

People on the banking side of things are not impressed by this argument. The funny thing, though, is they don’t provide any good arguments for why such assymetry of norms is a fair and just way to do business; instead they just reinforce White’s basic argument by pointing out how horrible strategic defaulters are:

“Borrowers who walk away from their mortgage obligations face serious consequences” including severely depressed credit scores for extended periods, Fannie Mae spokesman Brian Faith said. In addition, he said, “there’s a moral dimension to this as homeowners who simply abandon their homes contribute to the destabilization of their neighborhood and community.”

Lewis Ranieri, chief executive of several major mortgage-related companies and one of the pioneers of the mortgage securities industry, called White’s entire argument “incredibly irresponsible and misinformed.” Not only is the professor urging consumers to break legally binding contracts, Ranieri said, but if large numbers of them did so it would send home mortgage rates soaring and “tear apart the very basis” upon which mortgage lending rests — the understanding that borrowers will honor their commitments and pay back the money they borrowed.

And yet… if a business finds itself in an untenable financial position, it is considered smart to put a stop to things immediately and, hopefully, go on to fight another day. If only individuals had the same freedom in the marketplace.

“Homeowners! You Have Nothing to Lose But Your Mortgages!” [Metafilter]
“The moral dimensions of ditching a mortgage” [Washington Post]