Posted by With Big Shitpile rolling on, there’s been a lot of discussion about the ethics of defaulting on a home mortgage. Several people have commented on the hypocrisy of denigrating homeowners for doing the same thing that businesses do, without any moral qualms, so I won’t say any more about that here. What I do find odd is the inappropriate personalization of who holds housing loans. This is a typical attitude:
Tom Sobelman, whose family of four lives across the street from Ms. Richey, at 3127 Club Rancho Drive, sees mortgages as a moral as well as financial obligation. He’s still paying the mortgage on an investment property he owns nearby, despite the fact that the rent is about $1,000 a month short of covering his costs.
Mr. Sobelman, 37, argues that people who choose to default are unfairly benefiting at the expense of taxpayers, who have put trillions of dollars at risk to bail out struggling banks. “All these people are gaming the system, and I’m paying for it,” he says. “My kids are going to be paying it off.”
Imagine you’re renting from a landlord under a yearlong lease, and you decide that you’re not going to pay the last three months of the lease; you’ve decided you’re not going to renew, and by the time your landlord can evict you, you’ll be gone anyway. If enough renters did this, this would force landlords to raise rents to cover the missing months. This would be unfair to other honest renters, who through no breach of contract on their part, would now have to pay higher rents.
Arguably, if you walked away from a mortgage owed to a local bank, this would have a similar effect: other (future) borrowers would have to pay higher rates to make up the costs of the foreclosures. But this assumes that the primary activity here is providing a place to live, and some potential retirement equity. In light of the importance of having a place to live (and modest retirement equity), ‘playing by the rules’ matters.
But, over the last decade, housing has been transformed into an investment, which has made ‘playing by the rules’ inoperative in two ways. First, lenders willingly, if not enthusiastically, provided loans for overpriced housing: nobody went to the bank with a gun and demanded that they receive $500,000 for a housing loan, that, in a sane market, would have been only worth $300,000. It’s not as if banks and mortgage lenders had never evaluated property before. If you lock someone into an ‘underwater’ mortgage (the mortgage costs more than the house is worth), you’ve given the borrower incentive to walk away–this wasn’t a responsible loan.
This wasn’t about making a decent profit by enabling people to buy reasonably priced homes. In some markets, prices were increasing by thirty percent a year or more, while wages stagnated. A cautious lender would have pulled back. As Steve Randy Waldmann puts it:
I think that underwater homeowners ought to walk away from their loans for the very same reason McArdle wants us to consider them jerks for doing so. We both want to see norms we consider valuable enforced. I think that banks violated a great many norms of prudence and fair dealing in their practices during the credit bubble, and that they violate the fundamental norm of reciprocity by fully exploiting their own legal rights while insisting that borrowers have a moral obligation not to exercise a contractual option. In order to strengthen norms I consider crucial, I hope transgressors face legal and social consequences (strategic default and reduced shame attached to default) that will alter their behavior going forward… As a practical matter, I think we must rely on creditors rather than potential debtors to differentiate between wise and unwise loans.
The second problem stemming from transforming housing into an investment is that the loan itself became a commodity. Loans were sold to other parties (which caused itself trouble, since lenders had no long term commitment to the solvency of the loan), who in turned bundled those loans and sold them to other parties, who, themselves, often took out derivatives on these loans (and even derivatives on the derivatives). Whatever ‘community’ responsibility one has to honor debts, so that the lending system doesn’t breakdown, simply doesn’t exist. Many of the people hurt at this point are financial speculators that are extracting wealth, as opposed to creating it (by providing loans).
To put it more succinctly, it’s bad when the ability of your local bank to make housing loans tanks because you choose not to meet your obligations. But why should you feel obligated to honor Bear Stearns’ commitments? (Answer: you shouldn’t). We honor loans because we all profit by it, but if speculative activity increases the cost of housing (that’s what a housing bubble means), who cares if the speculators themselves take a haircut?
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