Friday, January 8, 2010

Should we hold homeowners to a higher moral standard than businesses?

In the wake of the collapse of the housing bubble, nearly 11 million American families are "underwater", meaning that they owe more money on their mortgage than their house is currently worth. Some of these families simply can't afford to make the mortgage payments. Others can make the payments, but have decided to walk away from what is clearly a losing financial proposition. By pursuing "strategic default", these families allow banks or other lenders to foreclose on their homes and eat the loss. This allows them to seek other housing options and re-build their financial lives. While this is often a good individual financial move, not everyone agrees that it is the (morally) correct thing to do. Roger Lowenstein's interesting piece in the New York Times Magazine highlights this point:
"John Courson, president and C.E.O. of the Mortgage Bankers Association, recently told The Wall Street Journal that homeowners who default on their mortgages should think about the 'message' they will send to 'their family and their kids and their friends.' Courson was implying that homeowners — record numbers of whom continue to default — have a responsibility to make good."
Mortgage bankers aren't the only ones who feel this way. The US government similarly discourages strategic default:
"The moral suasion has continued under President Obama, who has urged that homeowners follow the 'responsible' course. Indeed, HUD-approved housing counselors are supposed to counsel people against foreclosure."
None of this should surprise anyone. Lenders want to avoid defaults because they want to get paid back. And the government is desperate to stem the tide of financial losses and prop-up the housing sector. Further, defaults create a sort of externality: if I default, I can depress the value of the houses in my neighborhood, weakening the financial position of my neighbors.

However, in many cases default is the best financial option for individual homeowners. As Lowenstein points out, businesses use strategic default in the same sort of situations. Recently, Morgan Stanley walked away from buildings it owned in San Francisco, without incurring moral outrage. In their case, it was simply business.

While it's understandable that policymakers are unhappy with strategic default, it makes no sense to hold individuals to a higher moral standard than corporations. Any coercion from government to try and get people to keep paying their mortgage is essentially a transfer of wealth from homeowners to lenders. That is not, in and of itself, a worthy policy goal.

Rather, if the government is truly concerned with the strategic default, it could try a suggestion put forth by economist Dean Baker. Baker has advocated for "The Right to Rent Plan", which would grant homeowners facing foreclosure the right to rent their home for a period of 5-10 years from the lender at the fair market rental rate. Such a policy would give borrowers and lenders an extended period to work out mortgage modifications, which would prevent the externalities imposed on communities by foreclosures. It provides a better deal for the lender (who gets revenue from the rental fees) and the borrowers (who avoid the credit impact of foreclosure). Further, this would not require government revenue, nor would it unduly reward reckless borrowers or lenders.

We all have an interest in preventing future foreclosures, but guilt is probably not the most effective policy tool to achieve this goal.

1 comment:

Jason Schroeder said...

Nice post, Dan! This is the sort of thing I can see reading on the Op-Ed page of a major newspaper. You should consider submitting your best posts to newspapers. Might be a fun way to get yourself in print. Your writing style is clear and easy to digest. (I also read a few of your older posts.) And on this post in particular, I appreciated your argument. The idea of a banking industry who was pulled out of the fire by a huge government bailout lecturing some of the least-fortunate on the morality of their personal debt recovery plans is kind of absurd. I look forward to reading more!