Is it OK to deliberately default on an underwater home without a financial hardship? This isn’t a new debate. One side argues that the homeowner needs to accept responsibility for their actions while the other argues that foreclosure is the intended consequence of an unprofitable business decision.
While it is a good debate, in my opinion, it is the wrong debate. The focus has been whether it is legal, moral or ethical for a homeowner to walk away from their commitment to a lender. However, it’s time to focus on whether the circumstances of the current mortgage crisis were legal, moral or ethical to begin with. I have come to the conclusion that qualified borrowers that purchased during the boom were victims of massive abuses by investment banks in the mortgage markets.
Modern Day Alchemy
Wall St. had discovered a modern alchemy by putting a veil around sub-prime loans and getting them rated Triple A. Money was lent to unqualified borrowers then packaged and sold as a triple A security to investors worldwide. The reason lending standards were lowered to the ‘fog a mirror’ threshold was to create more debt. It didn’t have to be repaid, just last long enough so it could be quickly packaged and sold to unsuspecting investors. In fact, some of these same investment banks would then purchase Credit Default Swaps from AIG FP and profit again upon the failure of the security they had just sold as the ultimate in safety. Pension and retirement funds, as well as private investors around the world, having faith in the US ratings agencies and stability of the US mortgage and housing markets, purchased trillions of dollars in sub-prime Mortgage Backed Securities and Collateralized Debt Obligations (CDO’s). With T-Bills paying 1%, investors were desperately searching for investments with higher yields that could outpace inflation.
With trillions being lent to anyone wanting a nice home, genuine, qualified borrowers were forced to compete with borrowers that would never be able to repay loans. With an abundance of money in the mortgage market and a mushrooming population of artificial homebuyers, prices naturally skyrocketed. It was a false and unsustainable housing economy.
The more conservative among us would argue that Federal policies on affordable housing pressured banks into making bad loans as the source of the problem. In my opinion, while this compounded the problem, it was more of a plausible distraction to the greater abuse by investment banks. However, the government’s involvement made the increased availability of mortgage credit less suspicious and the rapid expansion of the housing market a credible event.
Regardless of whether you prefer to blame Wall St. or Washington for lending to people that could never repay, the housing collapse was not a result of responsible borrowers that simply bought a home at the wrong time. It was deliberate fraud and reckless abuse of a treasured American institution. The SEC complaint for Fraud against former Fannie Mae and Freddie Mac executives is hopefully just the beginning. I believe there should and will be more civil complaints as well as criminal indictments.
So, what should we expect as legally, morally and ethically appropriate from a homeowner that purchased a home under legally, morally and ethically corrupt circumstances?
Sacramento has thousands of families still trying to do the ‘right thing’ in homes that are $100k to $200k underwater. In my opinion, these owners need to do the math and really understand the financial impact of their decision to stay or leave. It is a decision with serious consequences… a choice between bad and worse.
Who is the Victim and who is the Villain
Those with equity in their homes are indignant about others walking away. But, how much remorse and contrition should we expect from a distressed homeowner that has been robbed because they had faith in the American Dream of home ownership and the financial and government institutions that make it possible? In my opinion, this wasn’t done by the homeowner; this was done TO the homeowner… and the taxpayer, and millions of investors all of whom simply had too much faith in the system.
I would say any homeowner that has stuck it out this long, overpaying for housing this many years, has demonstrated a more than reasonable commitment to honor the debt. In the final analysis, it’s time for us all to look deeper into the root cause and hold the real culprits accountable.
