Strategic Defaults Will Save the Housing Market

Walking away from a lousy, money-losing deal is lauded in the business world as a smart thing.  That is, if the walking is done by a corporation.

In the case of the drowning homeowner groaning under a mortgage that costs far more than his house will ever be worth, walking away is branded as irresponsible and un-American.

American Airlines decided to declare bankruptcy as a strategic move even though it could still afford to pay its bills.  It was losing money and didn’t want to “throw good money after bad.”  Its move was hailed as a smart business decision.

If a homeowner kept paying off debt attached to an asset that tumbled in value and would never recover, he/she would also be throwing "good money after bad."  Same situation, opposite outcome.

Candidate Barack Obama promised to set up bankruptcy courts for primary residence homeowners to restructure their mortgages when he became president.  That never happened. 

The banks’ attitude is do what I say, not what I do.  To paraphrase the business writer James Surowiecki in his article, “Living By Default” in the 12/19-12/26/11 issue of the New Yorker:

Banks] could have kept people in their homes by writing down mortgages, just as American’s restructured debt will reduce payment to its lenders.   

 Read “restructuring” as “reduce to manageable size".

There are ideas floating around that can ease the plight of underwater homeowners without involving taxpayer subsidies or rewarding irresponsible borrowers.  Eric Posner and Luigi Zingales of the University of Chicago suggest that banks:

[I]n exchange for writing down mortgages [reducing principal] in hard-hit areas [like Detroit, where 1 out of every 4 homes is a foreclosure], lenders would take an ownership stake in a house, getting a percentage of the capital gains when the house is eventually sold.

The “walk away” double standard burns homeowners’ dwindling cash reserves.  Banks count on social pressure to keep their borrowers from doing the smart thing.

To their delight, they keep collecting monthly mortgage payments from faithful underwater borrowers.  Therefore, they have no incentive to modify mortgages, whether allowing them to be refinanced at a lower fixed rate or reducing principal.   

Why should they, when they can take it all?  The status quo bleeds the homeowner dry at a quicker pace and gives the banks more money to leverage and loan.

All homeowners and sympathetic citizens [we’re in this together] have got to realize that it’s them or us, and do the smart, effective thing.  Strategic default as policy!