Underwater, But Will They Leave the Pool?

by Dollars and Sense

Some remarkable honesty about the class (although of course without using that term) dynamics of capitalism showed up in Saturday’s NY Times, in a piece by Richard Thaler about mortgage defaults:

Much has been said about the high rate of home foreclosures, but the most interesting question may be this: Why is the mortgage default rate so low?

After all, millions of American homeowners are “underwater,” meaning that they owe more on their mortgages than their homes are worth. In Nevada, nearly two-thirds of homeowners are in this category. Yet most of them are dutifully continuing to pay their mortgages, despite substantial financial incentives for walking away from them.

A family that financed the entire purchase of a $600,000 home in 2006 could now find itself still owing most of that mortgage, even though the home is now worth only $300,000. The family could rent a similar home for much less than its monthly mortgage payment, saving thousands of dollars a year and hundreds of thousands over a decade.

Some homeowners may keep paying because they think it’s immoral to default. This view has been reinforced by government officials like former Treasury Secretary Henry M. Paulson Jr., who while in office said that anyone who walked away from a mortgage would be “simply a speculator—and one who is not honoring his obligation.” (The irony of a former investment banker denouncing speculation seems to have been lost on him.)

But does this really come down to a question of morality?

A provocative paper by Brent White, a law professor at the University of Arizona, makes the case that borrowers are actually suffering from a “norm asymmetry.” In other words, they think they are obligated to repay their loans even if it is not in their financial interest to do so, while their lenders are free to do whatever maximizes profits. It’s as if borrowers are playing in a poker game in which they are the only ones who think bluffing is unethical.

Read the rest here.

An interesting detail from the piece is that in a number of states mortgages are “nonrecourse” by law, meaning the lender is entitled to the house but nothing else in case a borrower defaults. So borrowers in those states basically have the right to walk away, a right for which they pay an estimated $800 extra in closing costs per $100,000 borrowed.

Labels: Brent White, foreclosures, mortgage banking, mortgage default, New York Times, Richard Thaler, underwater mortgages

 

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1/25/2010 12:41:00 PM