Strategic Defaults (aka "Walking Away") are OK

I've kept mostly silent on this blog about a very important issue affecting the housing market -- strategic defaults. This is the phenomenon where a homeowner, so deeply underwater on their home, decides to stop paying the mortgage and let the bank foreclose upon the home. Some estimates say that this describes as many as 1 in 5 foreclosures, which is very scary considering that housing data shows around 23% of mortgage holders are now upside down on their home, and 0.11% (1 in 1000) homes in the US were foreclosed upon last month.

Well as you can imagine, I have strong opinions on this subject, but I've mostly kept them to myself. But since last night's 60 Minutes segment brought this issue to the forefront of national debat, I decided it was time to chime in.

60 Minutes interviewed Brent White, a University of Arizona law professor who wrote an influential paper on the subject last fall. I actually posted that paper on this blog around that time, but didn't opine on it.

Professor White is one of the leading academic advocates (if you can call them that) of strategic defaults. (It's sort of like being an advocate for assisted suicide; no one really promotes it because it's a terrible thing, but there are people who clearly advocate for the right to do it.) Professor White argues that an underwater homeowner has no moral obligation to the bank. The mortgage agreement clearly spells out what happens if mortgage payments aren't made (i.e., the bank takes over the house) so therefore the owner is upholding his end of the contract by turning over the house when payments aren't made. In addition, both Professor White and 60 Minutes both point out that corporations walk away from financial obligations all the time. Think of the many times that private equity firms turn over failing companies to the bondholders even though they could continue to service that debt (e.g., my old firm TPG Capital turned over Washington Mutual to the bondholders when their equity was wiped out). And closer to the real estate industry,  think of the many real estate developers who walk away from their equity and turn property over to debtholders (e.g., Tishman Speyer and Stuyvesant Village in NY).

I strongly agree with the theme of the 60 Minutes story: mortgage holders should act in their own best interest and if that means walking away from an underwater loan, then so be it.

I think it's funny how 60 Minutes sort of threw in there at the end a homeowner who thinks it's not right to strategically default, in order to provide some balance to the story. But even that homeowner concedes that maybe he should (and in fact maybe he will) walk away from his home.

In my opinion, the most valid argument against walking away is that it's really rude to your neighbors. It brings down the value of their home when your home becomes foreclosed upon; it's kinda like not mowing your lawn. I definitely see that point, but that's not enough to make someone feel guilted into throwing money away month after month.

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