More on Individual Market Freedom

It appears that the New York Times has finally caught on to what I’ve been saying since December: Homeowners – think like your bank.

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

The problem here, is something called “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.

One very interesting (dare I say, great?) way to combat this problem is nonrecourse loans.

That means the mortgage is secured by the home itself; in a default, the lender has no claim on a borrower’s other possessions. Nonrecourse mortgages may be viewed as financial transactions in which the borrower has the explicit option of giving the lender the keys to the house and walking away. Under these circumstances, deciding whether to default might be no more controversial than deciding whether to claim insurance after your house burns down.

This will serve to keep everyone honest about the transaction taking place.  For the bank, do they feel like they are giving an appropriately sized loan to a person who is adequately likely to repay, for a property that is fairly valued and poised to hold or gain value?  If so, grant the loan.

For the consumer, they are no longer worried about the extremely negative impacts that could result from these actions today – detrimental notes on their credit reports, legal proceedings (and the associated costs), etc.

But, these sorts of mortgages do come with a cost – about $800 in closing fees for every $100,000 loaned – a small price to pay, in my opinion.  Will these sorts of things become common?  Not likely any time soon:

So far, lenders have been reluctant to renegotiate mortgages, and government programs to stimulate renegotiation have not gained much traction.

So where does this leave the consumer?  Looking out for themselves, as usual.  If you are in this situation, and your financial institution is unwilling to work with you, I would offer that the ethical considerations of walking away should be just about the last thing on your list, if at all.

Would your bank think twice about foreclosing?

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