We find that 26% of the existing defaults are strategic. We also find that no household would default if the equity shortfall is less than 10% of the value of the house. Yet, 17% of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house. Besides relocation costs, the most important variables in predicting strategic default are moral and social considerations.
– "Moral and Social Constraints to Strategic Default on Mortgages," Guiso, Sapienza, and Zingales, June 2009
Advertisement - story continues below
Mortgage lenders are rightly terrified that more and more of the 22 percent of American homeowners whose homes are now worth less than their mortgages are going to exercise their borrower's right to default on them. At this point, most home defaults are still involuntary, but according to the paper cited above, more than one-quarter of them already consist of what the mortgage industry calls "ruthless defaults." And yet, why shouldn't homeowners be ruthless in their disregard for the financial interests of the home lenders when the lenders themselves have been utterly ruthless – and utterly stupid – in squeezing every last drop of potential demand out of the American public?
The housing crash was inevitable. The huge expansion in the number of home loans was an intentional attempt to expand the number of home buyers made possible by low interest rates, the widespread adoption of a risk-based credit model and political initiatives such as the Expanding American Homeownership Act. Of course, this short-term increase in the demand for houses drove up their price, which naturally led to an increase in the number of new houses being built. The problem is that this increase in demand was not sustainable for long, since there were finite limits on the number of homes that people who could afford them were willing to buy as well as the number of minorities in California who could make payments on the overpriced and predatory mortgage contracts they were actively lobbied to sign. (California was ground zero for the housing bubble, and by 2007 the median price of owner-occupied housing in California was 8.3 times median family income, nearly four times the national average in 2000.)
Once the limits of this artificially boosted demand were reached, the resulting excess supply of housing dictated the crash in prices that we are seeing today. The process has been a typical investment boom and bust, leading to a record number of American homeowners followed by a historic low of 41.4 percent in American homeowner equity and a record number of American homeowners in default.
The ramifications of the housing crash have been compounded by the corrupt and short-sighted decision of the Bush administration and the financial authorities to use taxpayer money to let the banks off the hook for the predictable ramifications of their reckless lending. As is so often the case with legislative intervention, the banking bailout has had unintended consequences resulting from the moral hazard it created, albeit less for the banks than for those who borrowed from them. Few Americans now see any reason why they should continue to pay the price for the negative consequences of their borrowing when the banks are being rewarded for the negative consequences of their lending. Nor should they. The banks were fully aware of the risk of potential default at the time they offered the loan.
Advertisement - story continues below
The idea that a homeowner should continue to throw away a significant part of his income in a recession on a property rendered less than worthless by debt in the interest of maintaining creditworthiness is stupid for several reasons. First, creditworthiness is what got the homeowner into financial trouble in the first place. Second, reducing and avoiding debt should be a priority for all responsible Americans, so being unable to obtain credit is hardly a bad thing. Third, it is laughable to suggest that banks which recently offered 125 percent subprime mortgages to unemployed illegal aliens on houses that cost an average of $312,400 will not be willing to provide credit in the future to a duly employed individual with one home default on his record. Banks exist for the sole purpose of providing credit; that is how they make their money. So many Americans have already defaulted on their home loans that it defies both reason and statistical science to believe that banks will not be making loans readily available to past mortgage defaulters in the future.
The banking industry threw out the old rules in the ruthless pursuit of increasing short-term profits with the full approval of the government and the Federal Reserve. None of these parties are in any position to protest how the American public has been forced to learn to play by the new rules established by the banks. There is nothing new under the sun.
[W]hen [Cato] was asked what was the most profitable feature of an estate, he replied: "Raising cattle successfully." What next to that? "Raising cattle with fair success." And next? "Raising cattle with but slight success." And fourth? "Raising crops." And when his questioner said, "How about money – lending?" Cato replied: "How about murder?" From this as well as from many other incidents we ought to realize that expediencies have often to be weighed against one another and that it is proper for us to add this fourth division in the discussion of moral duty.
– Marcus Tullius Cicero, DE OFFICIIS