People Are Not Corporations, and Financial Journalists Are Not Ordinary People

It is getting really old, the exasperation of entitled financial journalists that ordinary folks are not walking away from their underwater homes as much as they supposedly should. The latest to sound this tired refrain is James Surowiecki in The New Yorker (Living By Default, Dec. 19, 2011), who also makes the clichéd comparison to corporate decisions to shed debt using chapter 11 bankruptcy. He calls on underwater homeowners to do "the smart thing" by walking away.

According to Mitt Romney, “Corporations are people.” Whether or not you agree with that proposition, what is empirically true when it comes to debt is that people are not corporations. People don’t view walking away from debts that they can afford as a no brainer if it improves the bottom line. They agonize. They feel bad. They care about their homes and neighborhoods. Walking away is extremely painful, not a simple financial calculation. And, oh by the way, the further down you are in the 99 percent, the more likely that the financial calculation is negative, given impact on credit reputation from defaulting on a mortgage when your income is low. (On the other hand, many people worry about their credit reputations way after they have hit bottom and bankruptcy could actually improve their access to credit, more evidence that people don't take bankruptcy or any other form of walking away lightly.)

Of course, a lot more people are walking away these days, but not necessarily in the sense of “strategic default,” a phrase referring to those who can afford to pay. Rather, people are most often walking away because they can’t afford to pay. We don’t have decent remedies for the over-indebted to stay in their homes by paying their value, something that deserves attention before we worry about strategic defaulters, too.

“Moral hazard” has gotten a bad name from its cynical invocation by the mortgage industry, which created a Grand Canyon-sized pit of moral hazard by extreme risk-taking during the mortgage bubble (and subsequent bailout). Yet this industry dares to raise this concern about providing relief now that the bubble has burst, sweeping in even those who did not take risks but clearly cannot afford to pay their underwater mortgages in full now that the whirlwind not of their making has engulfed them.

If there were any seriousness about mortgage relief abroad in the land, we should already have had it in place two years ago, with Congress providing the ability to write down mortgages in bankruptcy. That approach would have addressed the risk of moral hazard, because debtors would have had to take the credit reputation hit of bankruptcy and also give up assets not covered by exemptions, if they had any.

So let’s stop the exhortations to the mortgage-afflicted to just walk away. I’d like to see someone who advocates this step publicly actually do it himself. Mr. Surowiecki, are you walking away on an underwater home you could afford to pay for and bragging about it, too? If not, maybe you should keep quiet about what others should do.

If we want mortgage relief to stabilize the housing market, there are lots of ways the government could accomplish that, given its control over of a vast number of troubled mortgages through its conservatorship of Fannie and Freddie. The Federal Housing Finance Agency could direct write-downs on underwater mortgages. But let’s not expect some uprising of ordinary folks who are underwater, and mostly feeling really bad about it, to lead us out of the current mess.

Comments

[Bob Lawless]

Absolutely. Many journalists and policy makers miss the point that moving is costly. It costs money, time, and emotional resources to move (which are similar to some of the reasons you identify). And, these costs are likely to be a higher percentage of the nominal value of the loan the "further down you are in the 99 percent." Even putting aside the points you make--and they are valid points--it can be a bad decision to walk away from an underwater mortgage just on a cost-benefit basis once you consider the costs on an "all in" basis.

[arrrgh]

"So let’s stop the exhortations to the mortgage-afflicted to just walk away."

usually i agree with you, but what are you thinking here?

hard tho it may be for the ordinary person to walk away, we should still encourage it. it makes financial sense and relief from the banks or the government appears to be unlikely.

[Jean Braucher]

Arrrgh, I feel your pain! But here's what I am thinking, since you were kind enough to ask: I don't believe in telling other people what to do, especially when they haven't asked. Beyond that, (1) it is not a simple calculation whether it makes sense financially to walk away (Bob makes some good points on that) and thus it is irresponsible to suggest that anyone who is underwater or even substantially so should do so, (2) the decision is not just financial for most people (many don't want to give up their homes and all the ties that bind them where they live), and (3) most important, making exhortations to walk away is not an effective public policy suggestion because the seriously underwater are not taking their cues from financial journalism (particularly in The New Yorker) and certainly not from law review articles or even this blog! We need a public or private initiative to get lenders/investors to start offering principal reduction through servicers. This notion of a popular movement, "De-Occupy Your Home," is a fantasy of the entitled; some people will do that anyway when they reach a tipping point, but let's talk about something more proactive, a program that might actually help to get principal reduction and keep more people in their homes, so that these are not added to the inventory driving down home values. A government program to do that may be unlikely (although conservative economist Martin Feldstein has urged it, http://www.nytimes.com/2011/10/13/opinion/how-to-stop-the-drop-in-home-values.html), but it is more likely than a popular uprising.

[Tom]

The government and well-meaning people should be actively encouraging and facilitating short-sales by people who are deeply underwater. Keeping them paying bubble prices for housing is prolonging bubble macroeconomic distortions and delaying recovery. Propping up the value of homes exacerbates wealth polarization - those who own less home equity are forced to pay more to those who own more of it, who are predominantly the wealthy, holding interests in mortgages indirectly via shares in banks and various kinds of investment funds. Propping up housing prices also delays recovery of the residential construction sector by discouraging people from buying and from forming new households, which is keeping a large backlog of defaulted and deeply underwater homes hanging over the market.

Of course the short-sellers' should weigh the financial benefit of short-sales against the costs to their social status, community attachments and preferences, and credit ratings. Government could help here by dictating rules to protect credit ratings of short-sellers, and with a program to encourage lenders to rent foreclosed homes to their former owners. The main reason this isn't happening, in my opinion, is that the government is mainly concerned about protecting the interests of the wealthy by propping up home prices and encouraging bubble-era borrowers to continue overpaying.

Frankly, I get the feeling this blog is discouraging "walking away" more out of protectiveness of its alternative policy prescriptions than out of genuine concern for the welfare of the underwater borrowers.

[Jean Braucher]

Tom, I am sorry if my point hasn’t been clear. I am not trying to discourage or encourage anyone from walking away. My point is very different. It is that ordinary people are usually very reluctant to walk away, and magazine articles, blogs and scholarly articles aren't going to change that. There has been a lot of that kind of encouragement over the last few years. Encouraging people to walk away is not a policy prescription that works. As for short sales, that means the person has to get out of the home. Sometimes a short sale is just what a person wants (and it is certainly better than foreclosure, which too often leaves the home vacant), but it is not responsive to those who want to stay in their homes but can’t afford a reset payment or who are having trouble justifying paying a huge mortgage on a home now worth much less. A short sale does involve principal write-down, so it is not a large step from that to principal write-down for people staying in their homes. Another idea with promise is allowing people to pay market rent, using a sale and leaseback, another way to get out from under an oppressive mortgage and start saving for other things—retirement, children’s education, and maybe homeownership again sometime down the road.

[Jay Wiedwald]

In the ForWhatItsWorth department, I've been tracking the history of all Trust Deeds issued in (hard hit) Alameda County, CA on June 14, 2006, the peak of the RE bubble.

As of two months ago, the homes of about one-half of the 56 Purchase-First loans recorded that day are still owned by that buyer, and 80% of those are current in their payments.

For whatever reason, a fairly large fraction of those most in the deepest are fulfilling their financial commitment. Whether that's the "rational" thing to do obviously has to do with a lot more than a financial decision.

[Monica]

I too have read several articles from "experts" encouraging people to walk away from their mortgages. In fact, some of them even suggested companies to use for those who choose "strategic default." I realize how many people are struggling to make ends meet, I have friends in the same situation. However, I agree with your suggestions of implementing alternatives to everyone just "walking away" from their homes.

[Chabot]

My take on the first part of Surowiecki's argument is that there's a point at which homeowners should walk away. Being underwater is neither necessary nor sufficient to lead to that decision, but it is one, among many, options, and one, among many, factors, that homeowners should keep in mind. When you weigh the costs vs. the various benefits, then you reach whatever decision works for you. I don't think that Surowiecki was advocating that everyone who is underwater should walk away, or that people should default more generally. Nor should this blog tell people to keep paying their mortgage or that they should count of relief that may not come. I view Surowiecki's second point as being that corporations tend to be very cold-hearted and calculated about this. Homeowners do face costs, like the hit to their credit scores and so on. But all of the soft stuff that you mention may matter from a pyschic perspective, but just like cleaning out your attic, you should ask whether it really does. Because otherwise, you're holding yourself hostage to things that matter only to you and not others. He may have made this argument backwards - starting with the corporations then drawing the analogy to homeowners - but I think that his basic point is correct: You should evaluate where you stand in determining how to approach your mortgage and should act accordingly. And you should be careful to overweight soft considerations, noting that corporations certainly don't feel that type of remorse.

[mt]

I agree with the author that the analogy to corporations is inapt. A corporation is just a legal form for shareholders to hold property and the corporation itself has no "skin in the game". It does not care about anything, including who owns it or where its HQ is located or whether the heat is turned on. Etc. The better anlaogy is to the shareholders they hold the equity in a corporation's assets, like the equity a person might have in a home. That is the substance; the corporation is the form and anyone who argues this issue by analogizing a corporation to a homeowner is not very smart.

That said, if the homeowner wants to walk away from a mortgage and can, they should. No one in that position should be deterred by feeling bad about the impact of doing so on someone else. It isn't very great, realistically. In many states, the option to do so was there at the formation of the contract, so exercise it. You bargained for it, in a sense.

But I do disagree that we should be writing down principal retroactively and coercively for people who stay in their house and continue to own it but can't pay for it. I think that is the worst idea around. That was never bargained for by either party to the contract and it discriminates in the award of a government benefit against those who do pay their debts, which is behavior that we want to encourage. We have a mechanism for not being able to pay your debts -bankruptcy. It's not at all bad on the debtor. Yes, I know that one can feel sorry for someone who has to move out of a house and neighborhood they like. But they will do so debt free, which is a fair tradeoff. It's not an unforeseen or unforeseeable risk at the time the loan was made.

Much as European leaders learned after Greece that, once you demand that private sector lenders "take a haircut", they tend to stop investing in the type of debt that leads to haircuts, if you want a functioning private mortgage market in the future, you need to honor the legal environment in which the mortgage loan was made. On both sides.

Finally, people need to understand that residential mortgage debt is a core asset of the retirement scheme in the United States and also that the federal government owns on a fully leveraged basis about 2/3 of the residential mortgage credit risk such that the loss from principal writedown is not one that would be borne by "the banks", it is a risk that would be borne much more widely, by taxpayers and pensioners all across the nation. There is no free lunch here.