The Wall Street Journal ran an editorial recently that discussed walking away from an underwater mortgage. In it, the Brett Arends argues:
You shouldn’t feel bad about it, and you shouldn’t feel guilty. The lenders would do the same to you—in a heartbeat. You need to put yourself and your family’s finances first.
It’s interesting. From the bank’s perspective (macro-economically): Except for the short-term cash flow issues that result from you walking away from your debt obligation, banks don’t care that you do it. You entered into a secured debt agreement (the best kind for the bank!) and the bank charged you 5% for money that cost 0.5%, at most.
Sure, it’s a pain that you walk away from your debt because now the bank has to deal with your property (it’s the asset and they don’t want it to lose value through neglect or abuse). It’s also going to be harder for you to get a loan in the future, but that should (and will) be the case in the future because of an upcoming change in accounting laws.
Banks that sell mortgage-backed securities and were forced to “mark-to-market” when they tried to sell that debt will need to start doing that annually. International accounting laws that the US plans to adopt in 2013/14 requires all assets to be priced at market price. This is a double-edged sword because the value of the assets now fluctuate. As a percentage of the investment value, the income generated by mortgage-backed securities will fluctuate. This isn’t something that most investors like, so I expect greater restraint in the derivatives market with respect to mortgage-backed securities. I wouldn’t be surprised if more mortgages were purchased and securitized by private investment capital companies who don’t need to comply with international regulations.
Investment insurance (very common in big business finance, though you don’t often hear about it) will also be harder to get for companies that want to invest in mortgage-backed securities. This played a crucial role in AIG’s collapse. They insured investments and then had a hard time paying out when the investments they made with their clients money also lost value and nobody wanted to buy them.
This insurance costs less than 10% of the value of the derivative (based on the Black-Scholes model), but it’s essentially money that you get back at the end. Warren Buffet’s insurance companies, like General Re, are very good at making a lot of money by getting insurance payments and investing them in cash-generating products and companies. They do it by also carefully picking the deals they insure and the investments they make with the money they hold.
So, not paying your monthly balance is also your right and option under your purchase contract. There’s no requirement to pay. In fact, the bank anticipates this and asks you to sign away your right to a jury trial in the event that you don’t pay. (Arbitration is less costly for the bank, and there’s nothing necessarily bad about it. Judges are usually smarter than juries, too.)
If morality entered into the collective consciousness of the financial world, they would have stopped adjusting interest rates, realizing that the deals they made were bad when they wrote the loans and that some money indefinitely is better than no money right now.
US Economic policy supports the American ideal of entrepreneurship and of risk-taking. Our country encouraged settlers to expand to the west coast in the 1800s. Donald Trump may be the epitome of this: Go Big and Go Bankrupt if you fail. Bankruptcy laws in the US are some of the most forgiving. It’s our policy that people take extreme risk with money. Maybe that’s changing, but it hasn’t so far.
A prime example of no morality or sense of collective good are the institutions who made deals that exhibited lack of “fair dealing.” Banks wanted money and home ownership was the government-sponsored gateway drug to separate people from their money. And if banks and other financial institutions play be a different set of rules than you and I do, why should we adhere to the same moral code that you and I do in our daily lives?
It’s darn hard, if not impossible, for those without power to enforce their moral code upon those with power. As long as the banks pursue money at any (human) cost, then the only power we have on a daily basis is to live within the walls of the contract and stop paying if it makes sense to stop. If you want to live in a house for 30 years, then keep paying your mortgage and you’ll have a great asset when you’re done. If you don’t want to, then it really is a financial decision. The decreased home values are the result of banks making it harder for people to get mortgages and continue paying their mortgages, not because there was a significant change in where you live.
