Should more homeowners walk away?

This post comes from Marilyn Lewis at MSN Money.

Economics writer James Surowiecki wondered out loud in The New Yorker why more homeowners don't default on their underwater mortgages.

After all, Surowiecki says, ditching unmanageable debt is common practice in business, where no stigma is attached:

We normally say that a company "went bankrupt," implying that it had no choice. But when, 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 it has been losing money for a while, and its board decided that it was foolish to keep throwing good money after bad.

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For a business, bankruptcy can be seen as a smart decision. For a homeowner, strategically defaulting -- you can afford to pay but walk away in the interests of the bigger financial picture -- the decision is characteristically deplored in moral terms.

Those who object on moral grounds usually say it creates a damaging social climate, a "moral hazard."

Bloomberg Businessweek describes such objections, by banks and some state attorneys general, in an article about discussions between banks, federal officials and states over lenders' foreclosure and mortgage-servicing practices. (A $26 billion settlement has been reached as a result of those talks.) Consumer advocates pushed for bank forgiveness of mortgage principal for underwater homeowners.

A key objection is the "moral hazard" created by the proposal to reduce homebuyers' loans because it "rewards those who simply choose not to pay their mortgage," the attorneys general said.

In an another denunciation of strategic defaults, here's David Walker, president and CEO of the Peterson Foundation, on CNBC's Squawk Box remembering when debtors' prisons encouraged a more responsible public. Walker "leads the Foundation's efforts to promote federal financial responsibility today in order to create more opportunity tomorrow."

You talk about debtors prisons, we used to have debtors prisons, now bankruptcy's no taint. Bankruptcy's an exit strategy. Our society and our culture have changed.

Speaking with a Wall Street Journal reporter in 2009, John Courson, the head of the Mortgage Bankers Association, evoked the moral argument against strategic default:

Defaults hurt neighborhoods by lowering property values, he says, adding: "What about the message they will send to their family and their kids and their friends?"

But, as Surowiecki points out, Courson's own organization recently negotiated a reduction of its mortgage debt:

Sometimes the hypocrisy is staggering: last winter, the Mortgage Bankers Association -- the very body whose president attacked defaulters for betraying their families and their communities -- got its creditors to let it do a short sale of its headquarters, dumping it for thirty-four million dollars less than the value of the building’s mortgage.

"It's a double standard that says corporations can look out for their best interests, but individuals can't," says Brent White, a University of Arizona law professor. He's the author of a much-discussed paper that examines homeowner motives, "Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis." (Here's a .pdf version from The Sacramento Bee.)

White and Surowiecki don't appear to be urging homeowners to bail on their homes. They're just pointing out the hypocrisy of moral arguments against it.

Homeowners who are considering bailing on a home have a decision to make that's a lot more complicated than just judging this dubious ethics contest. They also have to consider other arguments against walking away -- ones that at least make rational sense:

• Erosion of trust. A "wide-scale walkout would damage the mutual sense of trust and confidence in contracts that makes it possible to do business," Phoenix Realtor Bob Stahl, who has blogged about strategic default, told the Journal.

• Endless housing glut. If we all start treating our homes like investments, we'll never see the end of all the homes dumped on the market, Felix Salmon wrote at Reuters:

There would also be a huge rise in foreclosures, evictions, and fire sales -- with the result that house prices, which are still falling alarmingly, could see another stomach-churning lurch downwards. . . . … If Surowiecki wants millions of Americans to walk away from their underwater mortgages, I hope he knows where the buyers of those homes are going to be found. Because if they don't appear, we could have another massive housing crash and another huge recession.

• A home's just a home. Research by the Federal Reserve Bank of New York suggests that investors bringing bottom-line analysis to housing -- the practice of "flipping" homes -- was a big force in the bubble and bust. Salmon argues that a home is different from an investment, and if we all start treating our homes like investments, the housing market will become an endless and inhospitable cycle of volatility.

• Your credit will be demolished. There's a powerful personal reason for staying in an underwater home: damage to your credit. Foreclosure subtracts 85 to 105 points from a 680 FICO score and takes 140 to 160 points away from a 780 score, says MSN Money columnist Liz Weston. Getting new loans probably wouldn't be possible for at least a couple of years after foreclosure.

More on MSN Money:

• Are you foolish to pay your mortgage?
• 'Savvy' borrowers abandoning homes
• There's life after bailing on a mortgage
• Calculator:How much house can you afford?
• Who walks away from their home?
• The higher costs of strategic mortgage default