Tuesday, January 12, 2010

Ruthless default again

Last month I posted my thoughts on ruthless default concluding that, where legal, it is not particularly wrong.

Megan McArdle continues to argue the anti-default position. I found her arguments muddled and unconvincing.

First her list of pro-default arguments omits the main one, that it can be a legal way of saving yourself hundreds of thousands of dollars. A moral obligation has to be pretty strong to compel you to give up that much money and I don't see the case here. Note it doesn't make any sense to default if you are just a little bit underwater, this is only an issue for people who are way underwater. If you are happy with your home how much over market value would someone have to offer to get you to move? Quite a bit for me and I believe most other people.

Additionally many of McArdle's arguments against other pro default arguments don't make a lot of sense to me. For example:

All well and good, except that if you are walking away from a mortgage simply because the house is underwater, you have no authority to punish them. After all, the reason it was stupid to lend money to you is not that they were lending money to someone who probably couldn't pay it back; you can. The reason that it was stupid to lend money to you is that you're a deadbeat--a foolish deadbeat, who thought that house prices are a magic route to free money. That's not something they could reasonably have been expected to know. Also, "banks need to be punished for being almost as stupid and greedy as I am" doesn't have much of a ring to it.

But of course it is not foolish to obtain a loan on favorable terms. If house prices went up you got the profit, if they went down the bank took the loss. Heads I win tails you lose is not a foolish bet for me. And it is in fact stupid for banks to lend on such terms.

McArdle continued:

Moreover, those cheerleading such behavior seem to be under the misimpression that this will somehow be targeted at banks that made stupid loans. But the people who are walking away simply because the price dropped are not going to distinguish between good, sound credit unions with a conservative loan book, and big, greedy pension funds and charity endowments that bought residential mortgage backed securities. They're going to walk away from anyone holding the loan on a house where the price has dropped by more than the downpayment--which in places like California and Florida, is probably any house purchased between 2004-2007, no matter how conservative the underwriting.

Of course it is targeted at banks that made stupid loans. Which most non-recourse loans that don't require a substantial down payment are. And as I noted above people won't walk away just because they are a little underwater. This is especially true where a substantial down payment was required. Since people are reluctant to take losses they are a lot less likely to default when it means forfeiting a substantial down payment. So banks with conservative underwriting will have fewer borrowers walk away and they will lose less on the ones that do.

McArdle also claimed:

Okay, first of all, nothing would have stopped people from writing awful loans at the height of the bubble, because they didn't think the loans were going to go bad like they did. ...

This is nonsense. A legal requirement of 20% down would have stopped a lot of bad loans. Just as margin requirements prevent a lot of bad loans against stock.

McArdle also argued:

Except that banks would probably flood DC and state capitols with lobbyists trying to change the rules. There hasn't really been much value, up until now, in changing the recourse rules--I mean, banks probably prefer one to the other, but it's not their top priority, because people almost never default on their house unless things are so dire that there's no hope of recovering much anyway. If that changes, tougher rules become a top priority--and eventually, they'll probably get them, if the alternative is tougher underwriting, higher interest rates, and bigger downpayments.

First nothing is changing, people have always been willing to walk away when it was legal and greatly to their advantage. They didn't do so in great numbers in the past because banks maintained sensible underwriting standards. Second even if more people defaulting leads to changing the law (which I think is unlikely) this is not a moral argument against defaulting. You are not morally obligated to refrain from taking advantage of a tax provision just because if too many people take advantage of it the provision will be changed.

In summary McArdle asks people to voluntarily refrain from exercising legal options potentially worth hundreds of thousands of dollars for nebulous moral reasons. I don't understand why anyone would expect this to happen.

1 comment:

  1. I agree. We are talking about serious amounts of money. To put it another way, would you really want to tell your kids that you can't afford to send them to college because you don't want McArdle to think you're a deadbeat?