Posted on the Wall Street Journal's Developments by James R. Hagerty:
Many Americans are enraged by the thought that some people are simply “walking away” from their homes—in other words, ceasing to make monthly loan payments and waiting for the lender to foreclose. How irresponsible! How unfair to those of us who do pay our bills!
Brent T. White, an associate professor of law at the University of Arizona, has a different perspective: “Homeowners should be walking away in droves,” he writes in a new discussion paper entitled “Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis.” (Read the full paper.)
A failure to grasp the true economics of the situation is holding back many Americans whose home values have dropped far below the amount they owe and who would be better off renting, Mr. White says. Fear, shame and guilt also are preventing rational decisions, he believes. And, he says, those “emotional constraints” are encouraged by politicians and bankers, who ruthlessly and amorally follow their own economic interests while telling Joe Soggy Homeowner he has a moral duty to pay his debt so long as he possibly can.
How many people decide to walk away or, in other words, default “strategically” rather than by necessity? Mr. White quotes research—a study by Luigi Guiso, Paola Sapienza and Luigi Zingales, “Moral and Social Constraints to Strategic Default on Mortgages”—as estimating that only about a fourth of homeowner defaults are “strategic.” The rest are due to such things as divorce, job losses or other financial calamities that prevent people from meeting payments.
“The real mystery is not—as media coverage has suggested—why large numbers of homeowners are walking away, but why, given the percentage of underwater mortgages, more homeowners are not,” the professor says.
Mr. White figures some people keep paying because they overestimate the difficulty of repairing the damage to their credit record that would be inflicted by a foreclosure. Some may be overly optimistic about the value of their homes or the potential for a near-term rebound in prices. Others, of course, may simply like their homes and not wish to move into rental housing.
At the same time, there is still a stigma that comes with failing to pay bills. “Nobody wants to be identified as a deadbeat,” Mr. White writes, and a high credit score can be seen as a sign of moral fiber.
The fear of trashing their credit scores helps prevent some people from making rational decisions, Mr. White believes. That plays into the interests of the banks or loan investors, who want as many homeowners as possible to keep sending in those checks.
The professor wants to “level the playing field” between bank and borrower. How? One way, Mr. White says, would be to amend the Fair Credit Reporting Act to bar lenders from reporting mortgage defaults to credit bureaus. With that threat removed, he says, homeowners would have more leverage with banks and so would be more likely to work out a deal, such as a reduction in the principal due on homes whose value has plunged far below the loan amount. The bank and the borrower both screwed up in making a bad bet on real estate; now they could share the pain.
“It is time to put to rest the assumption that a borrower who exercises the option to default is somehow immoral or irresponsible,” Mr. White writes.
So is Mr. White walking? No, he says. He believes he is “just barely” under water on his house in Tucson, 3% to 5%. That’s “not enough that walking would make sense,” he says. Still, with refreshing modesty, he adds: “I can’t claim to be free from emotional and cognitive biases.”