The world’s largest guilt trip

November 30, 2009
Brent White shows that underwater homeowners across America are signally failing to take my advice (or that of Mark Gimein) and walk away from their homes:

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Brent White shows that underwater homeowners across America are signally failing to take my advice (or that of Mark Gimein) and walk away from their homes:

Only about one-fourth of homeowner defaults are strategic, with the other three-fourths triggered by job losses, divorce or other financial difficulties, which when combined with negative equity give homeowners no option but to let go of their homes. In other words, for the vast majority of homeowners, negative equity is a necessary but not a sufficient condition for default… Though more than 32% of U.S. homeowners were underwater on their mortgages by the end of the second quarter of 2009, the strategic default rate was roughly 3%.

Not all property owners behave like this, of course, and the best example right now of an underwater property owner walking away from his obligations is that of Sheikh Mohammed bin Rashid al-Maktoum. As Willem Buiter explains,

The shareholder (the al-Maktoum family aka the government of Dubai) will decide on ordinary commercial principles whether to provide additional financial support to these companies.

If the shareholder of Dubai World and of Nakheel believes that a further capital injection makes commercial sense, it will inject additional capital (assuming it can find the financial resources to do so). If, as I suspect is the case with Nakheel, the company is so deep under water that injecting additional shareholder capital would be throwing good money after bad, the company will not be financially supported by the shareholder. That’s how financial capitalism works.

Except, of course, that’s not how financial capitalism works in the US. Here’s White:

Luigi Guiso, Paola Sapienza, and Luigi Zingales found that 81% of homeowners believe that it is immoral to default on a mortgage, and that homeowners who hold this attitude are 77% less likely to declare their intention to default than those who do not. Indeed, once the equity shortfall exceeds 10% of a home’s value, the study found that “moral and social considerations” are the “most important variables predicting strategic default.” So strong are these variables, in fact, that only 17% of homeowners indicted that they would default if the equity shortfall reached 50%…

Moreover, foreclosure rates are considerably lower than would be suggested by the Guiso, Sapienza, and Zingales study, as the percentage of people who actually default is much lower than the percentage that indicated they would default in the survey, moral qualms or not.

White goes on to enumerate an astonishingly long list of institutions, up to and including the president himself, which are speaking with a single voice on this question, and saying that paying an underwater mortgage in full is the morally correct thing to do. Hank Paulson did it, despite the fact that he would have fired anyone at Goldman who behaved similarly; Neil Cavuto likened people who walk away from their mortgages to people who would have “quit” and handed over Europe to the Nazis.

Even Gail Cunningham, of the National Foundation for Credit Counseling, declared in an interview on NPR that “Walking away from one’s home should be the absolute last resort. However desperate a situation might become for a homeowner, that does not relieve us of our responsibilities.” If you’re thinking of walking away, you’ll almost certainly do so while overcoming enormous feelings of guilt. And where there’s guilt, there’s belief in dire consequences:

Most people simply do not believe they will escape punishment for their moral transgressions. Guilt and fear of punishment go together. Thus, the notion that one will suffer great consequences for walking away from one’s financial obligations not only seems possible, but feels quite right. It just can’t be that one can walk away from their mortgage with no significant consequence. As such, people rarely question apocalyptic descriptions of foreclosure’s consequences.

The result is a system tilted enormously in favor of institutional lenders who exist in a world of morality-free contracts, and who conspire to lay the world’s largest-ever guilt trip on any borrower who might think about joining them in that world. It’s asymmetrical, it’s unfair, and it’s about time that homeowners started being informed that a ding to their credit score is not the end of the world; that no one would expect a capitalist company to behave in the way that individuals are being told to behave; and that their options are in fact broader than they might believe. White’s paper is the perfect place for them to start their reading.

(HT: Kedrosky)


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