Strategic default: When homeowners make a “business decision” to walk away from their underwater mortgage (and home), not because they can’t afford it, but because it’s no longer in their financial interest to keep paying on it.

At least two recent media pieces have focused on that practice, and are worth a read/listen.

The first is from the NYT (January 23). An excerpt:

…millions of American homeowners are “underwater,” meaning that they owe more on their mortgages than their homes are worth. In Nevada, nearly two-thirds of homeowners are in this category. Yet most of them are dutifully continuing to pay their mortgages, despite substantial financial incentives for walking away from them.

A family that financed the entire purchase of a $600,000 home in 2006 could now find itself still owing most of that mortgage, even though the home is now worth only $300,000. The family could rent a similar home for much less than its monthly mortgage payment, saving thousands of dollars a year and hundreds of thousands over a decade.

Some homeowners may keep paying because they think it’s immoral to default….

But does this really come down to a question of morality?

A provocative paper by Brent White, a law professor at the University of Arizona, makes the case that borrowers are actually suffering from a “norm asymmetry.” In other words, they think they are obligated to repay their loans even if it is not in their financial interest to do so, while their lenders are free to do whatever maximizes profits. It’s as if borrowers are playing in a poker game in which they are the only ones who think bluffing is unethical.

The second is the January 29 edition of NPR’s Planet Money podcast. The attorney interviewed in that podcast asserts that defaulting is not against the law; that violating a contract is not illegal; that courts have never allowed punitive damages for breaking a contract.

And yet…I’m having trouble squaring the notion of “strategic default,” of breaking a contract simply because it’s no longer in one’s financial interest, with the fact that the person gave his word that he’d repay the loan.  Do his financial interests trump his word? Does the fact that it’s a business deal give him an out?

As one of my Mississippi REALTOR® friends suggested to me the other day, “Our whole civilization is built on agreements. If we stop keeping agreements, we stop being civilized.” And she added, “It’s bad to be without assets, but it’s worse to be without self respect.”

What do you think?