AnnotatedOpinions.com

. . . But with plummeting housing prices, many [homeowners] have faced a new reality: their home’s value is worth less than the mortgage. Maybe these owners are still employed; maybe they can still make the payments. But why should they? Financial gurus on cable TV are advising them to walk away, leave the keys in the mailbox, bid adieu to the lender – in short, to default. [AO: The reason financial guru’s advise home owners to walk away is not because these gurus have discovered a new way to dispose of a “troubled” home, it is because this is exactly the contract the homeowner and the his lender entered into. When a lender makes a loan, the lender prices into the loan the possibility that the home value will decrease and the lender will be left holding the bag when the homeowner strategically defaults. This is a risk the lender takes on and the lender is paid handsomely for this risk in terms of interest rates that it spreads across all of its borrowers.  

When homeowners choose not to strategically default, they are unilaterally agreeing to a higher interest rate above and beyond the rate the homeowner and lender agreed to. This higher interest rate goes directly into the pockets of bankers who can then pay record setting bonuses.   

Now, I’m not suggesting that every homeowner who can should strategically default. Instead, I am suggesting that homeowners should not allow ethical intimidation, fear or other forms of pressure to be the goad that is used to keep them in a lending contract when there is an out.]  

Strategic defaulters, though, threaten the larger economy. In 2001, 3.9 percent of owners of single-family homes had “negative equity.’’ In 2009, almost 25 percent had negative equity. If even half of those owners defaulted, there would be more depressed neighborhoods, more troubled banks – and, looking not too far into the future, stringent lending standards that would shut the doors of homeownership to the next generation. Lenders calculate risk: adding the risk of “strategic defaults’’ to their calculus would lead to higher down payments and higher borrowing rates. . . [AO: Strategic defaulters who default on their homes still have to live somewhere. They will rent in the same or another community. Think about it this way: if 25 percent of owners of single-family homes strategically defaulted, we’d need that many more rental homes. In other words, the economics is sifted from owning to renting.   

As for troubled banks, homeowners who contracted with banks cannot be expected to unilaterally increase their interest rate so that so-called troubled banks can continue to pay record bonuses. It’s unfair and unethical. Worse, it’s not part of the agreement between the homeowner and lender.  

Again, lenders were well aware that homeowners had the right to strategically default. Indeed, in many tax and finance classes across the country (mine included) professors have been explaining this to students for decades. Moreover, a number of states, including California and Colorado, are non-recourse states meaning lenders were on notice that they couldn’t even come after borrowers who walk away from their homes.   

Think about it this way: If Bank of America owed Citibank and discovered that the loan was underwater, would it continue to pay Citibank because of a concern for depressed neighborhoods, Citiban’s liquidity, or future lending to businesses? Of course not. Why then should John, who has a home loan with Bank of America, or Sue, who has one with Citibank, continue to pay that loan?  

Lenders already add the risk of strategic defaulters into loans. However, they miscalculated during the last housing boom just like they miscalculated the appropriate interest rates and the loan terms more generally. In the future, lenders won’t miscalculate or at a minimum they will try to be less wrong. Lenders will do this no matter what.]