Economics

Deadbeating Without Shame

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'Tis something, nothing; 'Twas mine, 'tis his, and has been slave to thousands.

Get ready for a new round of scolding news stories about how the generation raised on sexting and rainbow parties has reached a new level of shamelessness. There may be actual evidence that it's becoming cool to default on your mortgage.

Calculated Risk rounds up recent coverage of what one investor calls a new "badge of honor"—the scarlet D you get when you walk away from your underwater loan.

The stigma against default is fading at the same time support is growing for an expansion of the Home Affordable Modification Program (HAMP) to allow principal-reduction modifications for defaulting borrowers. James R. Hagerty at the Wall Street Journal's "Developments" blog cites many supporters of principal reduction schemes, and even proposes cockamamie fabtraptions like this one:

Here's one formula: The lender or other owner of the mortgage sells it at a big discount to an investor. That investor then reduces the loan balance and refinances the borrower into a mortgage insured by the Federal Housing Administration. Now Uncle Sam is holding the bag on a loan that (we all hope) might be sustainable.

When you combine easy principal reduction with fewer obstacles to default, you have a large group of home borrowers with a strong incentive to stop paying their mortgages. This recent New York Fed study [pdf] tracks redefaults of mortgages that have received steep principal haircuts (on average reducing principal by 20 percent). The study contains no surprises for regular Hit & Run readers, but it's nicely written and includes an interesting statistic on social acceptance of default:

A growing concern is that the "stigma" to a borrower from a default may be reduced in areas experiencing a severe shock to the local housing market. If several houses along a street are in foreclosure, then neighbors may not be surprised to hear about another neighbor defaulting on their mortgage, and may ascribe the decision to general problems in the housing market rather than any specific issues with their neighbor. In addition, neighbors who have defaulted themselves or who know someone who has defaulted may urge their friends to do the same if they are facing either payment problems or are in a negative equity situation. Fear of what will happen to a borrower if he/she defaults may be mitigated from conversations from friends or neighbors who have already gone through the process. To check for this in the data, we include the percent of subprime mortgages in the MSA that currently are 90 days or more delinquent. The data indicate that a 10 percentage point increase in the area delinquency rate raises the redefault risk by 8.2 percentage points.

The widespread principal-reduction and second-lien modifications proposed by Obama Administration officials would greatly inflate that figure—far more than would any popular acceptance of deadbeating. The popularity of strategic default has been growing for several years now. I know plenty of strategic defaulters, and they are not people inclined to worry about social niceties. And no matter what your friends and neighbors may think, there is still a penalty attached to defaulting—though not nearly as stiff a penalty as there should be: The Fed study describes a "roughly 200 point reduction in credit scores associated with a mortgage default." To put that in perspective, my credit score went down almost 100 points when I was late on a $90 phone bill. Giving up on a mortgage is the most severe debt default the average American is even capable of. If a 200-point drop is the worst you have to fear, why is anybody still making mortgage payments?