One problem stemming from the collapse of housing prices is that many households, even if they can still make their overpriced mortgages, are going to be paying far more for their houses than they should. That means less money for other things, from the frivolous to the important. So I’ve always wondered if we’ll ever get a flood of walkaways–people who let the bank foreclose on the house. I realize some people will want to stay in their homes–maybe they don’t want to pull their kids out of a school they like, or it’s just the wrong time to think about a move. But for many, the rational option would be to walk away. As Numerian observes, the last decade has done a good job of convincing people that honoring debts isn’t, well, an honorable thing to do anymore (italics mine):
The morality of paying back what you owe is therefore a matter of self-interest, and not something motivated by a sense of personal ethical behavior or contributing in some way to the common good. If there has been a breakdown in the willingness of some borrowers to pay back what they owe, and if this trend is growing, then something must be happening that makes it in the self-interest of borrowers to deliberately default.
…banks have severed their relationship with the homeowners to whom they have initially extended a mortgage. If you have a mortgage, you do not have a traditional borrower-lender relationship, and in most cases you don’t have a relationship at all. The homeowner is at the mercy of whatever mortgage servicer may be responsible for ensuring the homeowner makes their payment. The servicer works for the bank currently owning the mortgage, or for the investors, each of whom owns a small portion of the mortgage. When it comes to other products like credit cards or debit cards, banks have become so avaricious in imposing fees and penalties that the relationship has become that of predator to prey….
The only logical response Americans can make is, unfortunately, to become like the banks, and in certain circumstances walk away from their mortgages after weighing the consequences in a rational, business-like manner.
Investment manager Marshall Auerback argues that massive debtor revolt might be a good thing (italics mine):
On the other side, households and other non-financial institutions, whose dire finance is at the heart of the crisis, have received very limited help. Loan modifications programs and fiscal measures to raise their income and restore their creditworthiness have been too small to deal with the massive size of their financial problems, as we discussed in an earlier post.
All of which would suggest that it would not take that much to engender a situation where the country experienced a widespread debt revulsion. It might come to that, despite eminently more just historic alternatives, which Obama’s economic advisors could have drawn on, but chose not to….
if the American household sector repudiates debt by living in the house until the sheriff shows up without paying a mortgage, and then paying rent once they get kicked out, banks will then do what – shut new credit off to the private sector? Already done. In the meantime, the household sector (like Argentina when it repudiated its foreign debt) will have just increased the discretionary income and wiped the liability side of its balance sheet. Then it is just a matter of Mr Geithner figuring out another way to stress test the banks back into Treasury Dept. seals of approval, and voila, presto change!
Or maybe a debt repudiation of the magnitude we envisage might force President Obama to stop his seemingly endless appeasement of the Rubinite wing of the Democrats and embrace an approach which prevents US households from losing wealth of an amount equal to the negative equity they have in their respective homes, while the banks write down their assets to market.
Ironically, by overplaying their hand, the banks might be forcing the households to adopt an approach that will ultimately weaken the banks and expose them as the emperor with no clothes. They will take huge hits to their capital if faced with widespread debt repudiation. Now, I expect you’ll get a host of lawsuits and the very essence of the law of contract will come under attack if this scenario occurs, but the average American household might feel he has no choice and Obama might accommodate himself to these populist winds as he did in the Chrysler case, in effect overturning years of established bankruptcy law with no particular political cost to himself.
We already have congressional representatives telling people to squat in their homes. It could start to get very interesting in a year or two.