In the last two articles on this series regarding strategic default, we discussed the financial considerations and consequences of actively choosing to let a mortgage go into foreclosure, and we discussed the general conditions leading up to our current situation. This article is a continuation of the second article, Strategic Default: How We Got Here.
As we discussed in first article on strategic default, it makes sense financially to walk away from a mortgage when the balance owed is more than the underlying property is worth. But what are the consequences, and is it morally right? The very short answer (in this author’s opinion) is yes, very often it is morally right to walk away.
Lender’s Are Equally At Fault for Strategic Defaults
Setting aside lender fraud (things like lying on mortgage applications), the truth of the matter is that lenders chose to eliminate safeguards such as requiring a 20% down payment from borrowers. Now it’s true that many borrowers took advantage of the system and became speculators, but banks and other lending institutions knew it was happening and continued lending. The worst part of the story is that banks and lenders also knew that a meltdown could occur. Other markets that entertain speculators are strictly regulated. However, the strict regulations do not apply to real estate speculation. Banks and other lending institutions saw an easy way to make a ton of profit by extending credit, and they chose to ignore the known risks of a “real estate bubble.” “Bubble” is a term that just refers to unreasonably high prices, and when a bubble bursts, prices plummet.
Unlike you and me, when the real estate bubble popped, the federal government bailed out the banks, even though the banks knew all about the risks they were taking. And that, to me, is the real difference between the banks and real estate speculators: Banks knew without a doubt that they were helping to create a bubble. Some real estate speculators knew too, but they were not in a position to stop it. A speculator can only choose to participate or not to participate. Banks, on the other hand, could have required 20% down payments. They could have tightened lending standards.
Those Considering Strategic Defaults are Victims
The bottom line is that unless you were aware of all of the above and all, it’s quite possible that you are a victim of the greatest scam of all time–a scam that allowed banks to take huge risks and get bailed out when their bets failed. In light of that, how could it be immoral to walk away from a bad, underwater loan?
If that’s not enough, here’s another moral reason to walk away: It will help normalize the market. By holding on to an underwater property, you are signaling that you believe the property is worth at least as much as is owed on it, even if you know the contrary. By allowing such a property to go into foreclosure, the market can find the correct supply and demand equilibrium and establish prices that reflect true value. Even more importantly, current lending regulations make loans more difficult to obtain, so you would essentially be trading a “bad,” speculation-prone mortgage into a “good,” long-term asset.
As one final observation, I have had discussions with a number of attorneys who have told me many of their clients with strategic defaults on their credit records are suffering minimal adverse consequences in terms of finding new lines of credit or gaining employment, because foreclosures are now so widespread and commonplace. Just something to keep in mind . . . .
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