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Jan 10

Intentional mortgage defaults

Unlike Australia, many mortgages in the US are no-recourse. This means that if a homeowner (the mortgagee) defaults on their loan, they can just give the bank the house keys and walk away without suffering any other penalty. In a market where a homeowner’s home loan costs more than the value of their house, it can make a lot of financial sense to voluntarily default and then walk away from it all. But there’s a stigma against this, despite this sort of call being made in the corporate world all the time. The New York Times examines this state of affairs in an interesting article.

Of course, from one point of view, a contract is a business deal and there should be no moral stigma attached to breaking it, because as a legal instrument, the innocent party has avenues of redress which theoretically compensate them for their losses. “It’s just business, not personal,” as they say. In the case of home loans, the “innocent party” is a big lending corporation which is knowingly bearing the risk of making loans which are no-recourse.

There are two reasons why so-called strategic defaults have been considered antisocial and perhaps amoral. One is that foreclosures depress the neighborhood an drive down prices. But 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.

The other reason is that default (supposedly) debases the character of the borrower. Once, perhaps, when bankers held onto mortgages for 30 years, they occupied a moral high ground. These days, lenders typically unload mortgages within days (or minutes). And not just in mortgage finance, but in virtually every realm of our transaction-obsessed society, the message is that enduring relationships count for less than the value put on assets for sale.

  5:50pm  •  Business & Finance  •   •  Tweet This  •  Comments (1)

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1.  Ros

This was the topic of an especially interesting Freakonomics blog last February – as usual, the most revealing discussion lies in the comments!


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