Dec 13, 2011
A defense of "strategic default"
13 Dec 2011
Posted by Andrew Kantor
First and upfront: This does not necessarily reflect the views of your humble writer, nor that of VAR or any of its officers, staff, caterers, etc. This is just for filing under “Hmm… interesting point.”
Interesting piece in the New Yorker about strategic default — mortgage holders deciding it makes more sense to walk away from a mortgage rather than continue to pay it.
The reaction of some might be, “Hey, they signed an agreement to pay the debt, they don’t get to walk away!” But it’s not that simple.
Quoth the New Yorker:
[W]hen, recently, American Airlines filed for bankruptcy, it did so deliberately. The airline had four billion dollars in the bank and could have kept paying its bills. But … its board decided that it was foolish to keep throwing good money after bad. Declaring bankruptcy will trim American’s debt load and allow it to break its union contracts, so that it can slim down and cut costs.
American wasn’t stigmatized for the move. Instead, analysts hailed it as “very smart.” It is now generally accepted that when it’s economically irrational for a company to keep paying its debts it will try to renegotiate them or, failing that, default. For creditors, that’s just the price of business.
In some areas, well over half of mortgages are underwater, many so deeply that people owe forty or fifty per cent more than the value of their homes. In other words, a good percentage of Americans are in much the same position as American Airlines: they can still pay their debts, but doing so is like setting a pile of money on fire every month.
These people have no hope of ever making a return on their investment in their homes. So for many of them the rational solution would be a “strategic default”—walking away from the mortgage and letting the bank take the house.
So the question worth discussing is, which is true?
- We’ve made “strategic default” via bankruptcy an accepted business practice, so there’s no reason it shouldn’t also apply to homeowners. If walking away is best for the family financially, “for creditors, that’s just the price of business.”
- Businesses shouldn’t be allowed to file for bankruptcy any more than homeowners should be allowed to walk away from their mortgages. If they can’t pay their bills, they go out of business.
- These are two different things, and the comparison is over-simplified. (Explain.)
Once again, I’m not putting forth an opinion here, I’m simply saying, “Hey, this is worth discussing.”