Those of you who listen to the show somewhat regularly will know that, while I’m a big fan of markets, I’m also highly critical of one of the central tenets of neoclassical economics – the “rationality assumption”. In short, in order for its predictive models to work, neoclassical econ requires that all of the agents in a market act rationally, and with perfect information. In test after empirical test, it’s been demonstrated that the ability of most people to act rationally in most situations is, shall we say, highly suspect.
One example of this is pointed out in the NYT today: for many people suffering through dramatic declines in their home prices, the “rational” choice is to simply walk away from their mortgages. This is a consequence of the policies that created the home mortgage market in the first place (and also an example of one of my other favorite talking points – namely that markets are created, not born … but that’s for another post). Regardless of the moral feelings, social pressure, or hit to their credit scores that those who walk away from their mortgages may suffer, the fact is that this is not only LEGAL, but the CORRECT, rational response to declining home prices and an “underwater” mortgage.
The NYT piece explores the reasons why more people don’t just walk away. It’s a good read. For my part, I’ll just say that if you really want to s***w the banks (and why not?), then support the idea that people with underwater mortgages just walk away from their properties. Plus, it’s the right thing to do for the economy.
I agree. I think in a rational world, the banks would choose to re-write the mortgages, and reduce the principal. But for whatever reason, the banks have decided it’s not cost-effective for them to do so (probably because they’re not holding the mortgages anymore — they’ve been securitized and sold off).
The only caveat I would add — and it’s a small one — is that just because you’re underwater on your house, you don’t *have* to walk away. Everyone is “underwater” with their car, for example, because cars are depreciating assets. But we don’t all just drive them to the nearest safeway parking lot and toss the keys. You have to decide (a) what are the costs associated with moving, (b) how much will you have to pay to rent a similar house (gotta live somewhere), and (c) how much do you care about destroying your credit rating. Once you’ve calculated a, b, and c, then yes, walking away *may* be a rational choice.