Monday, December 21, 2009

Reducing the shame of default

Original posted on Reuters by Felix Salmon:

Steve Waldman has been doing a spectacularly good job of teasing out the moral and financial implications of homeowners walking away from their mortgage obligations, and delivers another great post today:

I think that underwater homeowners ought to walk away from their loans for the very same reason McArdle want us to consider them jerks for doing so. We both want to see norms we consider valuable enforced. I think that banks violated a great many norms of prudence and fair dealing in their practices during the credit bubble, and that they violate the fundamental norm of reciprocity by fully exploiting their own legal rights while insisting that borrowers have a moral obligation not to exercise a contractual option. In order to strengthen norms I consider crucial, I hope transgressors face legal and social consequences (strategic default and reduced shame attached to default) that will alter their behavior going forward…

McArdle favors a world with both easy credit and easy bankruptcy. I favor the easy bankruptcy, but not the easy credit. I think that debt arrangements are hazardous and should be entered into only with great care. I don’t consider increasingly leveraged homeownership and aggressively accessible consumer credit to have been positive developments. As a practical matter, I think we must rely on creditors rather than potential debtors to differentiate between wise and unwise loans. So I consider it a feature rather than a bug that holding creditors accountable will encourage them to think twice before sending out convenience checks.

While you’re chez Steve, you should also check out the letter he got from a soldier on the same issue. The basic insight here is that if a large number of morally serious individuals refuse to walk away from their debts, then we as a society are essentially letting banks off the hook for systemically-dangerous atrocious underwriting. Meanwhile, the banksters are grinning from ear to ear: to the extent that they haven’t been bailed out by the government, they can happily get bailed out by individuals who will end up paying hundreds of thousands of dollars just so they don’t need to worry about being considered to be “jerks”.

If there’s less shame attached to default, we will end up with exactly what we want — less badly-underwritten credit, a more solvent society, and much less tail risk. We went far too many years believing without really analyzing the proposition that credit is nearly always a Good Thing. Now that we’ve learned just how harmful it can be, it makes sense to reorient our aspirations and norms in the direction of a world where credit is both rarer and safer than it is right now.

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