Tuesday, June 29, 2010

The "Strategic Default" Outcry (UPDATE)

The matter of a borrower walking away from his mortgaged home, where the value of the home has dropped below the outstanding indebtedness, has been getting a lot of attention recently. The Miami Herald has an article on the subject today, and Glenn Reynolds links to this post on the Atlantic Magazine blog. The Herald article cites some surveys that indicate that nearly 19% of home foreclosures are the result of a solvent homeowner (a homeowner who is apparently able to service the mortgage) simply walking away from the house that he bought (and financed) at what now appears to have been a very inflated price.

The idea suggested by some of these reports is that the "strategic defaulter" is doing something immoral, and that someone (maybe the government) ought to do something about it. The strategic defaulter is contrasted with the upright debtor who plugs away at his debt, figuring that someday the market will correct itself and some equity will appear or that the walk-away price he would pay (the moving expenses, the taint on his credit history, and the prospect of a deficiency judgement - see discussion below) is too high a price to pay.

But before getting to the issue about the character of the borrower, the matter of a "deficiency judgement" needs to be kept in mind. A "deficiency judgment" is what the mortgage lender gets when it receives less in the foreclosure proceedings than what it is owed. It is the difference between the balance due on the mortgage and the market value of the house. It is the very thing that prompts the "strategic defaulter" to walk away in the first place.

The catch for the defaulter is that he is personally liable for the deficiency. Not only that, but the deficiency judgement will also include the bank's attorneys fees and all other costs associated with the foreclosure. What the creditor will do with its deficiency judgment is to turn it over to the sheriff for collection or a collection lawyer who will scour the countryside for the debtor's assets. By definition, the "strategic defaulter" has other assets, because this is a person who could have kept up the mortgage payments if he weren't such a smart . . . smart . . . smart . . . (Mr. Vice-President, can you help me here?).

Now why won't the banks simply go after the strategic defaulter's other assets with a deficiency judgment? Part of the reason may be that the paperwork was so sloppy when the financing was done that the bank is going to have a rough time proving its deficiency case in court But whose fault is that? Or maybe the strategic defaulter is just barely in that category, so that it turns out there aren't that many assets upon which to levy the deficiency judgement. But whose fault is that? Or maybe tracking down the assets is not going to be that easy. But whose fault is that? Or maybe it turns out the debtors assets are all "exempt" under his state's debtor protection laws or the Bankruptcy Code, a situation that would have been disclosed on the loan application documents, if the loan officer had only reviewed it carefully and not been distracted by the fee his bank was going to get. (In the case of fraud on the loan application, we would not be dealing with a "strategic defaulter" but with a criminal, for which there are other penalties.) If you want to talk about moral turpitude, may we please talk about the banks here? They are the ones who are supposed to be the defenders of prudence in the market place.

But, of course, the banks were enabled by the likes of FNMA, which was enabled by . . . our government. So if we are going to cast moral aspersions, let's make sure we have our targets properly sighted. I believe number one on the list has to be the federal government.

And it would be just like the government (and the government's defenders in the press) to blame the "strategic defaulter" for the problem rather than itself.

If there are a bunch of "strategic defaulters" out there (and, frankly, I doubt that there are as many as these surveys indicate), then we must assume that each of them has run the numbers, understood the costs and the risks, and finally made a hard-headed walk-away decision. Such a person is merely exercising his rights, based on the bargain into which both he and the lender entered into freely. And I say, if there really are such people as "strategic defaulters" and they see a net gain in the walk-away, then go for it.

UPDATE: Carol dissents. And, of course, she has a point. In a perfect world, everything would work out: banks would loan prudently, the government would not be a player but a referee, deficiency judgments would be generally collectible, and borrowers would not take imprudent risks. But we are not in a perfect world. Should, then, the debtor be concerned only with his own economic self-interest?

Should a Christian act differently? Isn't the discipline of the market place, when things get out of kilter because of negligence or greed in the particular transaction or elsewhere in the economy, how God more or less keeps the lid on this fallen world? Is the Christian aggravating a bad situation by failing to act as a self-interested economic, pagan actor or is he helping the situation? Whether he is helping or not, should he do what he promised to do? (He did, after all, make a promise.)

If we put it simply on the basis of keeping a promise made to another, a promise on which the other relied, then the matter becomes pretty clear. And Carol's right.


Carol said...

Thanks. :)

Macon said...

I don't think that economic, mutually beneficial agreements, necessarily constitute a promise. The agreement also stipulates the way in which the agreement may be broken. These aren't promises like a marriage promise. That kind of promise has no "if it doesn't work out clause". (And here I take the view that pre-nups are non-marriages, but rather are merely contractual agreements. How about that?) But mortgages DO have a, "this is what happens if you don't pay," clause, which presupposes that one might not pay, which means that the person who loans is making an economic decision, not one based on a promise.

Carol said...

You make a good point. But sometimes just because you CAN do a certain thing doesn't mean you OUGHT to do that thing.

Paul said...

Good comments. See my post on what a "promissory note" that is secured by a mortgage actually says.