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The virtues of paying your mortgage

Tim Lee makes the case for paying your mortgage even when it's not economically beneficial to do so:

In college, I had a friend who occasionally shoplifted. I wasn’t shy about voicing my disapproval of this practice, and I would have cut off friendship with him if he kept doing it. This anti-shoplifting norm benefits everyone. The stigma against shoplifting is a much more powerful, and less costly, check on the behavior than anything that happens in the formal legal system.

I think the same basic analysis applies to defaulting on a mortgage. Personally, I wouldn’t do it (unless I had no choice) because that’s not how I was raised. And I think it’s a good thing that defaulting on a mortgage carries a stigma. The existence of social pressures to pay mortgages has the same salutary effect on the mortgage market that the stigma of shoplifting has on the retail market: it relieves pressure on the formal legal system and allows businesses to be more trusting of their customers. I suspect that if everyone adopted Matt’s attitude toward mortgage defaults, interest rates would be higher and there would be more people who wouldn’t be able to get a mortgage at all, because they couldn’t scrape together a down payment.

On the other hand, one of the lessons of the housing crisis is that we shouldn't be trying to hammer interest rates down and making down payments smaller at the cost of long-term affordability. Since the norms discourage people from walking away from their houses, few do it. But that means people have a lot less experience with the idea that housing can be a bad investment than the numbers would actually imply. If potential homeowners saw more people walking away from their mortgages, they might think twice about stretching to get a mortgage of their own.

By Ezra Klein  |  January 12, 2010; 3:21 PM ET
Categories:  Housing Crisis  
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Comments

Why is it ok for corporations to walk away from CRE, when they are underwater?

Posted by: srw3 | January 12, 2010 3:37 PM | Report abuse

The other problem with this analysis (which overall has some merit) is the asymmetrical nature of the social pressures. Business long ago publicly rejected the idea that they owe anything to their communities or their workers: they began saying emphatically that their only obligation is to their shareholders. However, social norms haven't caught up with this change. The result is that there is still pressure on consumers to act honorably, while business is seen as free to do whatever it perceives will maximize shareholder value.

Posted by: beckya57 | January 12, 2010 3:43 PM | Report abuse

This is absurd. Shoplifting is a crime. Defaulting on a contract (especially one that contemplates default and includes penalties for it) is not a crime. The comparison makes no sense.

Here's the problem that's tying the rich and righteous and their apologists up in knots. They want to bind ordinary citizens to disadvantageous contracts by imposing the burden of moral standards on their behavior. But when ordinary citizens ask that the rich and righteous conform their behavior similarly, we are told - "oh, no - free markets - we are assessed only on our bottom line."

Lee is horrified by a world in which everyone acted as free agents in the free market. That's a privilege he wants to reserve for those with capital. They do much better when ordinary income earners conform their economic behavior to moral standards they themselves would never submit to.

With few exceptions, as I read the comments of economists on the crisis, its causes and consequences, I increasingly find myself in favor of confiscatory taxes for bankers.

Posted by: mimber1 | January 12, 2010 3:46 PM | Report abuse

I'm with Tim. Think of the collateral effect. The communities, he schools, the families left with no sense of stability. Sure it's hard to be bankrupt, owing more than somethings worth. But those are the EXACT times you need to know your neighbors, the kids' need the stability of home, etc. Ditch the mortgage, it will be like renters sneaking off in the middle of the night in the Great Depression -- psychological effects. Plus, few have the chutzpah to stick around in the same town, buying again. There's a stigma. Mobility is overrated in family situations; young people being irresponsible, sure. Old folks learn to stick by the benefits of their bargain, for better or worse. Then you know your neighbors when the good times come too.

Posted by: Mary42 | January 12, 2010 3:47 PM | Report abuse

Lee is horrified by a world in which everyone acted as free agents in the free market.

Not true. You can act as a free agent in a free market ... just don't sign a contract binding you otherwise. Think before you commit. Because others who do, don't want to live next door to an abandoned property or pay off the benefit of your bargain.

Posted by: Mary42 | January 12, 2010 3:50 PM | Report abuse

Another problem is the issue of externalities. Defaulting on your home mortgage drives down the rest of the neighborhood's property values. I could even imagine a situation where a bunch of defaults on a street send other home owners underwater and cause a default death-spiral.

Posted by: daw3 | January 12, 2010 3:50 PM | Report abuse

Morality is a two way street. Blatantly exploitative products, like "no-doc" mortgages and subprime mortgages with low initial payments and massive rate jumps later, were sold to unsophisticated buyers by "experts" who both collected high fees for doing so and ignored traditional underwriting standards. Walking away from a mortgage is more like paying a cancellation clause on a contract than it is like theft. Bankers have worked hard to craft a lot of special protections for themselves (no mortgage cramdowns in bankruptcy, for example).
If they don't like the terms of mortgages, they use different ones henceforth.

A CEO who lays off half his workforce does not then get to complain about a lack of employee loyalty to the firm. An industry that sells trap products with lots of "gotchas" should not be surprised when their customers look to the letter, not the spirit, of the contracts, too.

Posted by: adonsig | January 12, 2010 3:55 PM | Report abuse

What mimber1 said.

Shoplifting breaks a law (a social contract between citizen and State). Defaulting breaks a civil contract with a bank. Society is directly harmed in the first instance, and only indirectly harmed in the second.

And all those indirect effects of defaulting (lowering your neighbors' property values, affecting credit ratings, etc.) are all really just the symptoms of a market being corrected by rational actors. If homes fall to their true market value, and lenders require a certain downpayment and credit score of the buyer, why is that a bad thing? 'Less you like inflating bubbles.

Posted by: jeirvine | January 12, 2010 4:03 PM | Report abuse

@Mary42--When a corporation walks away from an office building, it lowers lease rates for the remainder of the buildings in the area. Why should individuals be held to a higher standard than corporations?

Hey, when you do not fufill the terms of a contract there are legal consequences. If those consequences are less burdensome than paying for a property that is underwater, then walk. That is what any corporation would do in a similar circumstance.

Remember, it was leverage by bankers that facilitated and deepened this crisis. Why should individuals adhere to contracts where the consequences of not adhering are less than the consequences of paying an underwater mortgage?

Plus the govt made big banks whole through massive amounts of capital so that the banks didn't default on their CDOs and MBSs. Why didn't they have to suffer the consequences of not being able to meet their contractual obligations. Individuals are not getting anything near that level of support from THEIR (not the banks') government.

Posted by: srw3 | January 12, 2010 4:08 PM | Report abuse

In addition to what @mimber1 said regarding criminality, the social stigma and penalties for shoplifting are far less than those for an abandoned mortgage. "Everyone adopting Matt's attitude toward mortgage defaults" is a red herring and the analogy is stretched beyond its breaking point.

Posted by: BigTunaTim | January 12, 2010 4:12 PM | Report abuse

Defaulting on your home mortgage drives down the rest of the neighborhood's property values.

Nonsense. There was a real estate bubble that burst: underwater home mortgages and falling property values are unavoidable consequences of this, not cause and effect. Property values are coming down one way or another.

Posted by: tps12 | January 12, 2010 4:26 PM | Report abuse

This is an insane analogy. First off, this is a contract, not a crime. If you lose your job, and cancel your cell phone contract and pay the penalty for early termination, nobody calls you a shoplifter. Why the heck are we supposed to believe mortgages are different?

Secondly, there are no bad market effects from rational default.

The reason banks give you mortgages isn't because they have an belief that you will behave irrationally. This is why the way home loans have traditionally worked is the bank gives you a loan for LESS than the value of the home, and you pay the bank back because otherwise they will take your house and you will lose a lot of money.

The problem we have now is that the collateral system broke because bad lenders created a housing bubble when they lent to people who they knew couldn't pay the home loans back.

If people walk away from underwater mortgages, so what? How would this change the mortgage market for responsible lenders? Not a whit.

Posted by: theorajones1 | January 12, 2010 4:27 PM | Report abuse

"I suspect that if everyone adopted Matt’s attitude toward mortgage defaults, interest rates would be higher and there would be more people who wouldn’t be able to get a mortgage at all, because they couldn’t scrape together a down payment."

Two things:

1. The idea of "scraping together" a down payment is a good indication of someone who shouldnt be buying a home. 10-20% down used to be the rule, and should be again. Then u wont have to worry about defaults when the borrower has skin in the game.

2. The goal isnt for there to be as much credit available as possible, any more than we should worry whether or not there's enough casinos available. Credit is necessary and important, but only in the hands of people who have the capacity to use it without damaging themselves and the banks.

Posted by: zeppelin003 | January 12, 2010 4:38 PM | Report abuse

*Defaulting on your home mortgage drives down the rest of the neighborhood's property values.*

Thus placing those property values more closely in line with what they should be.

Everyone is talking about the bad consequences of the homeowner defaulting on his mortgage. What about the bad consequences of the bank taking too long to resell the house, the bank's refusal to renegotiate the principal on the mortgage, and the bank's inability to process paperwork in a timely manner? But we don't place moral stigmas on the banks for not "supporting the community" in these situations. We force that obligation on the borrowers.

You know what else carries a stigma? Not being properly prepared for your retirement and not being able to support your children's college education. I hope I'm never in a position where I'm hundreds of thousands of dollars underwater on a mortgage, but if I am, I hope I will know how to balance off which social and economic stigmas.

Posted by: constans | January 12, 2010 4:41 PM | Report abuse

I dont like the analogy either.

But here's the thing - would you advise a family member to continue to struggle to pay for something for 30 more years at the expense of their childrens education or their own retirement security? Would you advise your child to cash in her 401k to pay a few more months on a home she will most certainly lose anyway? I would not.

There is a difference between what people are starting to call "strategic defaults" and those sad cases where people lose their homes because they lost their job or there was an illness in the family, divorce, or disability.

The "strategic default" is a pretty crummy way someone of means (otherwise able to pay) takes advantage of laws originally designed to protect people who, through "no fault of their own" find themselves in desparate straits. I think this is the moral dilemma if there is one. If a mortgage were not so central to the American Dream (TM) then would those laws exist in a form that allows some people to take advantage?

Posted by: luko | January 12, 2010 4:42 PM | Report abuse

"The reason banks give you mortgages isn't because they have an belief that you will behave irrationally. This is why the way home loans have traditionally worked is the bank gives you a loan for LESS than the value of the home, and you pay the bank back because otherwise they will take your house and you will lose a lot of money."

But many mortgages WERE predicated on people behaving irrationally, that is, buying more house than they could afford, signing contracts with disadvantageous terms they couldn't understand, allowing brokers to fill in the blanks on "ninja" (no income, no job or assets) loans etc. And they were syndicated on the premise that investors would buy instruments they didn't understand but were told would earn a high rate of return. In its latter stages the whole system was based on people continuing to act irrationally.

Defaulting on a mortgage is a civil breach, not a crime. But many of the mortgages were the result of criminal conduct by brokers and lending institutions. The would-be homeowners were mostly victims, who may walk away from a mortgage but the stigma on their credit rating is lasting.

All of this argues for more regulation of lending institutions, not letting free markets be free. There is no end to human greed, and it has to be policed more when social norms shift to a Randian selfishness and lack of concern for others.

Posted by: Mimikatz | January 12, 2010 4:52 PM | Report abuse

I'll join the chorus: this is a stupid analogy even if you believe we owe some unique moral debt to mortgage lenders. Indeed, I'd argue that in a market economy, the morality works exactly the other way. To pay your mortgage when it makes no economic sense is immoral, since it destroys the foundation of the capitalist economy.

As a loony leftist, I have been amused deeply to see self-styled establishmentarians and capitalists argue this line. I never knew we were surrounded by old-style Wobblies seeking to build the new society in the shell of the old. Good on you, kids. The IWW needs new blood.

Posted by: wcwhiner | January 12, 2010 5:25 PM | Report abuse

A lot of these discussions seem to be of the theme of poor taken advantage of homeowner and the evil banker who tricked the poor sap into buying a house he couldn't afford. Therefore there's no moral obligation on the part of the poor sap of an homneowner to continue paying his mortgate to the evil banker. The thing that's missing in this whole discussion is personal responsibility. Did the banks make a mistake of offering mortgages to people who couldn't afford them? Of course they did. A lot of banks got caught up in the housing feeding frenzy of a couple of years ago, aided and abbetted by your friendly, helpful federal government, and are paying he price now just like everyone else. Most banks aren't getting the big fat bailouts the Wells Fargo's and Citibank's are getting. But when it's all said and done the guy who signed his name on the bottom line of the contract agreeing to purchase a house he couldn't afford has to be the one who has ultimate responsibility and should pay the price for his stupidity. No one made him sign that contract. He just got greedy and thought the housing boom would last forever, completely contradicting all of history, and he could cash out in a few years with a big profit. Even the poor schmuck who just wanted to live in his $500,000 house with his $30,000 a year income has to take responsibility for the contract he signed. Even though now the bills are coming due on the exotic mortgage he signed up for, in the glorious days of 100% yearly appreciation on housing, is now much higher than what he was paying initially. And if he's able to walk away from this obligation due to his own stupidity then shouldn't he also be able to walk away from all his other obligations: credit cards, light bill, water bill, car payment etc.?

Posted by: RobT1 | January 13, 2010 10:56 AM | Report abuse

Instead of shoplifting, let's make the closer analogy: returning an item that's defective, or that you got by mistake, or that just doesn't fit the way it seemed to in the store. The store gets the item back, but can't just put it right back on the shelf; you get to keep your money, minus the inconvenience and the cost of shipping, and maybe a restocking fee.

Obviously stores would be thrilled if consumers felt a moral obligation not to return merchandise even if it was defective. But most of them have found it more profitable in the long run to get a reputation as not being unpleasant greedheads than to reap a little bit more in the short term by making returns difficult or impossible.

Along those lines, there's a solution to the "But what about the neighborhoods?" plea: if you don't want people to exercise their right to walk away, make it worth their while to stay. People aren't leaving their houses for fun, they're leaving because their banks aren't interested in making compromises so that neighborhoods can be preserved.

Posted by: paul314 | January 13, 2010 12:09 PM | Report abuse

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