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November 17, 2011

What disease and strategic default on mortgages have in common

A new report conducted for a mortgage-industry trade group likens "strategic default" -- walking away from a mortgage you can afford to pay because you owe more than your house is worth -- to a contagious disease.

It's not just the idea that strategic defaulters spawn more strategic defaulters. The report's authors focus much of their attention on real estate experts -- "mavens" -- who advocate such a move and sway underwater homeowners to their way of thinking. 

"Much the same way as a disease spreads throughout a population, so too do decisions to 'strategically' default," the report concludes, adding: "Mavens are more contagious than non-Mavens because people place greater trust in their opinions. ... In fragile markets, advice by influential Mavens can result in a flood of strategic defaults, causing a contagious downward spiral of home prices and potentially a market collapse."

The report was sponsored for the Mortgage Bankers Association's Research Institute for Housing America. Last year, the bankers association's then-CEO said would-be strategic defaulters should think about the damage they would do to their neighbors' property values and their own reputations. "What about the message they will send to their family and their kids and their friends?" John Courson told The Wall Street Journal at the end of 2009.

That just before the Mortgage Bankers Association sold its headquarters building for millions less than its 2007 purchase price -- and millions less than its financing, too. The WSJ reported at the time that the association would not disclose the terms it negotiated with its lenders, but sources thought the group would be paying back only part of the $30 million that the sale price hadn't covered. Irony lovers had a field day.

People have debated the ethics and bottom-line considerations of walking away for several years now. The ethics argument boils down to whether paying your debts is a moral obligation or a contractual one (i.e. "I pay the mortgage or I give you back the house, so here's the house, buddy"). On the financial side, there's the chance to get out from under a house that might never be worth what you paid for it vs. the effect on credit scores, the ability to get security clearances and the possibility of future dunning attempts.

Some states are non-recourse, meaning that mortgage holders can't come after you for the difference between what you owe and what they can sell the house for. Others -- including Maryland -- allow the debt collectors to come calling.

Last year I wrote about a strategic defaulter who was planning to file for bankruptcy protection after he walked away from his Baltimore home.

So, folks: What do you think of strategic default nowadays? Do you think the "disease" theory is apt?

Posted by Jamie Smith Hopkins at 7:09 AM | | Comments (2)
Categories: Walking away / strategic default


It is a disease, but only for bankers and a house of cards banking system where money is conjured into existence by issuing new debt. For in that system, when debts go bad through loans being defaulted on, money is literally destroyed, contracting the money supply, causing deflation, and creating a feedback loop that puts more downward pressure on assets for which leveraged finance is primarily used.

While it is true that the Federal Reserve creates money, that is only part of the story. The full truth is that approximately 9 out of every 10 dollars in our total money supply were created through completely private banks through the process of taking out loans, and making even more loans that are built atop of those loans.

If you'll pardon the cartoons, and have about an hour to spare, you can learn the exact same material about how this system works that is taught in a college money and banking course, albeit with a little bit of added commentary. There's one textbook that is used for probably half the colleges in this nation, many of them the Ivy League, the Mishkin text, that presents the exact same information regarding the mechanical workings of our fractional reserve system. The history presented is consistent with Harvard professor Niall Ferguson's "The Ascent of Money."

5 part video in 10 minute clips:

And if you understand the work of Emmett H Welch, as well as some of the more modern empericism regarding the Great Depression, you'll understand that deflation raises real wages, inflation lowers real wages, and to that end the debate over fractional reserve vs. full reserve banking really is one of the landed aristocracy and bankers versus everyone else.

Why should strategic default be acceptable in the business world, but somehow wrong for individuals conducting personal affairs? If an individual has negative equity in a house and qualifies for bankruptcy protection and relief, it is perfectly legal to walk away from the mortgage. In fact, the bankruptcy court may require it. So, why pursue an unnecessary bankruptcy, when walking away is an option? Businesses that lend money for profit know there is risk involved, and it is factored in to the interest rates they charge. I don't understand why this is such a dilemma for some consumers. It is perfectly rational to get rid of a bad mortgage as quickly as possible.

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About Jamie Smith Hopkins
Jamie Smith Hopkins, a Baltimore Sun reporter since 1999, writes about the regional economy. Her reporting on the housing market has won national and local awards. Hopkins is a Columbia native and has lived in Maryland all her life, save for 10 months spent covering schools in Ames, Iowa.
She trained to become a wonk by spending large chunks of time as a geek and an insufferable know-it-all.
Baltimore Sun articles by Jamie

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