The Breakdown

Explaining Southern California's economy

Strategic mortgage defaults: Nothing wrong with that!

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34271 full

The L.A. Times' Michael Hiltzik is appalled at the moralizing going on around "strategic defaults" — a default on a mortgage undertaken from a position of cold, hard financial calculation, rather than from some sentimental notion that a borrower should always, always pay, no matter what cards life deals him:

What often gets overlooked in the debate over walkaways is why it should matter. A default is a default, isn't it? [Old Dominion University's Michael J.] Seiler, for one, disagrees — he argues that defaults for noneconomic reasons have a uniquely corrosive effect on social behavior.

That's based on the notion that borrowers have a moral obligation to pay their debts. Yet a mortgage contract is a legal document, not moral catechism. It doesn't require you to make your payment regardless of your financial state; only that you recognize that if you don't, you might lose your house.

Mortgage lenders customarily try to price the likelihood of delinquency or default into the loan; that's why borrowers with the best credit scores typically pay the lowest interest rates. Nor is the credit score a gauge of moral purity — it's an empirical reflection of the borrower's debt load and bill-paying record.

You could also argue that a high credit score isn't the best predictor of potential to default. Someone with outstanding credit could be reduced to someone with less-than-outstanding credit, through job loss or sudden injury. True, they probably have other assets besides the house they can draw on. But should they? Or does their presumably higher level of financial sophistication make them more likely to go strategic? I kind of think the latter...

One of the positive things to come out of housing crisis is that more people now see their homes as a simply financial edifices — assets they purchased through a structured relationship with a lender. You used to hang on to the home at all costs because it was seen at your most important investment. Or because you loved living there.

But what we've learned since 2009, with the stock market generating a once-in-a-lifetime buying opportunity, is that are plenty of investments that can massively outperform real estate. Homeowners have also grasped that they may have to endure many years of negative equity or reduced financial flexibility due to their commitment to a mortgage. 

So while there may not have been an epidemic of strategic defaults, Hiltzik is absolutely right to point out that if we ever go through this again, there's nothing wrong — and maybe plenty right — with walking away from a bad loan. Not a bad house.

Follow Matthew DeBord and the DeBord Report on Twitter.

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