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If You Were Upside-Down, Would You Walk Away From Your Home?

My father, who passed away in September just shy of his 86th year, started very poor, worked very hard, hated owing money, and was overjoyed when he was able to pay off the mortgage, in advance. Surely not everyone in the 1970s enjoyed sending money to a bank quite as much, but in today's bizarre real estate and mortgage markets, a significant number of people are willingly making the decision that was once unthinkable (to my dad, at least) -- "strategically" walking away from their homes and mortgage obligations, even when financial circumstances don't force them to.

My dad in 1939, graduating from Davenport
High School, Plymouth, Pennsylvania.

In the past week both The NY Times and The Wall Street Journal have chronicled the rising number of people voluntarily walking away from their homes, for the reason that they are "upside-down" or "underwater," which is to say they owe more than the house is currently worth.

In "Short Sales, A Long Process" -- see all the clever headlines we writers can get from this crisis? -- The Times explains that the expectation of lots of short sales has fallen short. (In this context, a short sale is a transaction where an underwater homeowner-borrower finds someone to buy the property, at less than the value of the mortgage, and the bank goes along because it's not as drawn-out and costly as a foreclosure.)

[Large numbers of short sales have] not yet happened, industry experts say, largely because lenders and investors who hold the liens on second mortgages and home equity credit lines often fight for a larger piece of the short sale proceeds.
Lenders say they prefer loan modifications but will accept short sales because they lose less money on such transactions than they do in foreclosures, which often require them to carry the house for months before selling it.
No mention of the social contract, moral obligation, whatever, that the borrowers have to their neighborhood, bank or economy. Or the example they set for their children.

In The Journal, we are told of a "Debtor's Dilemma: Pay the Mortgage or Walk Away." Here, the writer has a clever lead -- "Should I stay or should I go?" -- from an old rock song. The Journal does address the moral question, though:

George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay -- and weren't deceived by the lender about the nature of the loan -- have a moral responsibility to keep paying. It would be disastrous for the economy if Americans concluded they were free to walk away from such commitments, he says.
Here are the numbers: Oliver Wyman, a consulting firm to financial institutions, working with credit raters Experian estimate that 16 percent of today's foreclosures are "strategic," where borrowers keep paying their other debts, and selectively stiff the bank. That's up from three percent five years ago. At Northwestern University, scholars estimate that one in four foreclosures is by choice.

And the walkaways are concentrated in a few states: California, Arizona, Nevada, Florida and Hawaii.

Why are people doing what was once unthinkable? Because they can, says economics eminence grise Martin Feldstein:

The no-recourse mortgage is virtually unique to the United States. That's why falling house prices in Europe do not trigger defaults. The creditors' ability to go beyond the house to other assets or even future salary is a deterrent.
Not every state allows no-recourse mortgages, but there's an overlap with those showing lots of walkaways, say Andra Ghent of Baruch College in New York, and Marianna Kudlyak of the Richmond Federal Reserve Bank, in a recent research paper. (The body of the paper is quite dense with equations, but there is a useful appendix with thumbnail descriptions of mortgage laws of the 50 states. Ten allow no-recourse mortgages.)

Their mathematical models say that the probability of a voluntary default is 20% higher in states with no recourse.

They also posit that the chance of walking away increases with the value of the property. There's no difference under $200,000, but for properties worth more than $500,000, they reckon a 66 percent to 100 percent greater chance of default.

Maybe the rich are different.

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