Why Are Homeowners Idiots?

http://www.fool.com/investing/general/2010/01/26/why-are-homeowners-idiots.aspx

by prat • 16 years ago

33 84 16 years ago

I generally agree with the sentiment that one is morally obligated to pay debts. This article makes a good argument that free markets don't work on morality, instead they are rooted in the assumption that everyone acts in their personal best interest.

Anytime I think about the morality of abandoning an underwater debt, I remember that $billion corporations do this every single day.

tc2• 16 years ago

Free markets are also deeply rooted in strong and fair contract enforcement. That's the bounds-check on self-interest.

steveplace3• 16 years ago

And the US markets have some of the best bankruptcy courts in the world, which helps.

CWuestefeld• 16 years ago

This article makes a good argument that free markets don't work on morality, instead they are rooted in the assumption that everyone acts in their personal best interest.

I read it with just the opposite meaning. I understood it to say that the actual, observed behavior in the mortgage market is that howeowners are being moral. The Fools seem to question why people would act following their morals rather than purely financials.

And this points to one of my favorite misunderstandings of economics, and one that I'm surprised an economist would fall for. Economics is NOT about just money. It's about why people make a choice for one thing, foregoing another. And it's all tied to what people value.

It seems to me that this article validates that people really do value behaving morally, having a clear conscience. And I'm glad, because I don't want to live in the world where people take advantage just because they can.

chrisgoodrich9• 16 years ago

That is an interesting contrasting viewpoint. You are absolutely correct that the observed behavior is to act morally (as they should). I had missed this point earlier.

brc• 16 years ago

And if you want to go studying Adam Smith for some 'invisible hand', you first need to understand the 'Theory Moral Sentiments'. You are correct in that it's what they value. This is the monetary aspect + other aspects. It's clear to me the reason that people with underwater houses don't default because of the credit history damage, social stigma and other feelings. Plus, they may consider walking away equivalent to selling at the bottom of the market.

The article, overall, adds very little to the discussion because it approaches it from the wrong angle.

billjings• 16 years ago

Homeowner's opinions will likely change if they begin to perceive their lenders as taking advantage of that morality.

whyenot• 16 years ago

There's an awful lot of experimental evidence coming from psychology that most people do "take advantage just because they can," especially if they think nobody is watching.

If you could anonymously walk away from a financial obligation like a morgage, people might behave quite differently.

maweaver• 16 years ago

Do you have examples of big companies abandoning debts like that? The opposite actually comes to my mind: large companies being destroyed by their inability to get rid of underwater debts (putting aside big banks' recent problems, I'm thinking of Enron here)

chrisgoodrich9• 16 years ago

General Motors comes to mind. Bankruptcy allows them to abandon their debt and continue to operate with only the best assets as the "New GM." Basically all the same assets, screwed the stockholders and debtors, but a new company.

mrkurt2• 16 years ago

Ignoring bankruptcy for a second, big companies walk away from contracts all the time. Those contracts normally stipulate that one company will pay another company a certain amount of money over a particular time period, which is effectively debt.

The difference between that and a mortgage is that the big companies are usually on a more equal negotiation footing than homeowners are with banks. So rather than signing a boilerplate agreement, they have teams of lawyers to pick things over, write outs, etc. So when they choose to "walk away", they usually have some reasonable way to do it and still comply with the contract.

toddh• 16 years ago

You are obligated to do what your contract says. Your contract says you can walk away and the bank gets the house. If the bank didn't like that potentiality because they were speculating on a loan, then apparently that's all of our problem.

zmimon• 16 years ago

I don't know exactly what mortgage contracts look like in the US, but the ones I have seen in my country don't say you can walk away. They say you can not walk away. The bank getting the house is just one consequence that happens if you violate the contract and do walk away.

mrkurt2• 16 years ago

It's worth reading your specific mortgage, but it's likely that the contract says something along the lines of "you walk away, the bank gets the house, you're liable for the bank's losses".

kyteland• 16 years ago

I tend to agree with the sentiment put forward by Karl Denninger at http://market-ticker.denninger.net/archives/1791-Finally-Mai...

"Years ago there was stigma - a man's word was his bond. But that is gone now, and it is not you, the consumer who made it thus. It is in fact the very people who lent you that money who made it so - who proffered documents to you written in 4 point type that were impossible for anyone with less than a PhD to understand (and sometimes even then), that contained intentional tricks and less-than-honest inducements, and who themselves were in fact stuffing bogus loans into securities that they then peddled out to the masses!"

prat5• 16 years ago

Its not the morality but the expectation of the housing prices bouncing back to normal like the rest of the economy that is keeping them from walking away.

But the issue with realestate is that its not as agile a market as stocks or commodities. the volatility observed in a month in the stock market is probably going to be observed in a year in real estate market. And I am not not even talking about the phase lag but the different scales of variation between the 2 types of markets.

ars• 16 years ago

> Its not the morality but the expectation of the housing prices bouncing back to normal like the rest of the economy that is keeping them from walking away.

Then they could walk away, and buy a different (cheaper) house, or buy first then walk away.

prat5• 16 years ago

There is cost of walking away, damage to credit. So if they stay, assuming things will get better and they do, they keep their credit too.

lurkinggrue2• 16 years ago

Housing prices were not normal when many were buying.

axod3• 16 years ago

Over the long term, on averga, house prices always rise. People always need places to live.

lucifer• 16 years ago

"And let me emphasize, any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator -- and one who is not honoring his obligations." - Paulson

Every time these GoldmanSachs critters open their mouth is yet another oblique reminder that the masses are brain dead.

chrisgoodrich9• 16 years ago

"Do as I say, not as I do." comes to mind.

simon_• 16 years ago

Has Goldman Sachs ever missed an interest payment or otherwise failed to met a financial obligation?

The ire in Paulson's quote is directed not against speculators generally, but speculators who don't live up to their agreements when things move against them.

That's not really something Goldman is guilty of. ...As much as people would like them and everyone ever associated with them to be guilty of everything.

johnrob• 16 years ago

Didn't he short the housing industry? You'd think he'd want people to walk from their mortgages.

steveplace3• 16 years ago

Different Paulson.

GabrielBen• 16 years ago

With finances you always have to sit down and do the math, which could be already a fair ammount of work.

I think that this situation happens in part for the "moral"restrictions, in part for the credit rating, but also because of the effect that once that you invested a certain ammount of money in something, you keep pouring money on it even when its not good for you.( the famous throwing good money after bad money)

"i have already commited to buying this house, and pay this much already, so i might as well put more".

Im sure many of the readers here have put money into fixing their computer several times before acknowledging that to buy a new one would be cheaper :).

wjy• 16 years ago

Also, the financial aspect is just one part of the total consideration. I've been in my house for ten years, and we've made a life here. We have quite a bit of stuff in this house. It would be a huge pain in the ass to move, as well as disruptive to my family, my son's school life, etc.

Being underwater today doesn't imply being underwater next year. A home's value may return, so long as you didn't buy at some idiotically high price.

tc2• 16 years ago

This is how societies break down.

An example is set at the top, by those in power, that self-dealing and self-interest above all ethical standards is standard operating procedure. Eventually this moral decay 'trickles-down' and people start to realize that they are chumps if they don't start playing by the same rules.

pyre4• 16 years ago

The problem is that they are chumps if they don't play by the same rules. Which is why the people 'at the top' really need to be used as an example of not acting in such as self-interested way. If the people at the bottom are keeping society together by ignoring the example set at the top, then the people at the top are just plowing over everyone else in a bid to further their own selfish goals.

Psyonic• 16 years ago

Agreed. Either the common man should play by the same rules, or he needs to fight to enforce that those at the top don't get to cheat either. Otherwise he is basically a "chump."

andylei• 16 years ago

there may also be the issue of credit score. if you file for bankruptcy, it's harder to get a loan in the future. the prospect of future loans may be more valuable than the difference between what you owe the bank and the value of your house. that said, i suspect most people aren't thinking about this

chrisgoodrich9• 16 years ago

This is an important point that I think supports the overarching message if this article and the Paulson quote. The system of credit reporting has been setup to support this "debt as a moral obligation" assumption. The fear of poor credit scares people into continuing to pay.

In reality, a bankruptcy only lasts 7 years on your credit report and most banks will start lending after merely 2-3 years.

Underwater homeowners should look at the longer time horizon and see that it will take quite a few years for their assets to be above water. That's several years to re-build their credit with a much lower cost of living.

lionhearted• 16 years ago

> In reality, a bankruptcy only lasts 7 years on your credit report and most banks will start lending after merely 2-3 years.

From my understanding, it goes off your credit score but banks can see past bankruptcies forever and it factors into their decisionmaking on whether to lend and what interest rates and terms to offer.

This is what my business banker said to me when I was chatting with him casually - so consider the bias, but he's quite the straightforward and standup guy and we're acquainted a bit outside of the bank. He's not the kind of guy that'd pull my chain (and I didn't have any debt anyways - was just getting a rundown on credit scores). Actually, it was pretty damn illuminating when he told me all of the stuff they have records on - they knew all sorts of information about me that I never gave them.

kls7• 16 years ago

It is 10 years and one can get an auto loan in less than a year if they understand how the mechanisms work. The over-reliance on credit score can be used to a bankruptcy filers advantage if they are careful. A bankruptcy usually take a 60 to 100 point hit on ones credit, not at all devastating. The problem is that most people wait to file after they have missed several payments which, each take a toll, on an individuals credit score. If one files at the first sign of trouble, can hold out making payments until the filing and immediately gets a secured credit card after the fact they can repair the damage in a little as a year. You will pay at least a point hire interest for the 10 years it is on your credit.

As well, with so much flight from underwater homes I would not be surprised to see the government enact some form of credit forgiveness once the wreckage is cleared and we are recovering. We have to get all of these consumers back to consuming or our consumer based economy will not survive. Both the corporations and the government are in favor of happy consumers who are pacified by their consumption so they will be extremely interested it lighting that economic "engine" again.

kscaldef2• 16 years ago

I agree with you almost completely, except that I'm pretty sure that most people in this situation are, in fact, considering the consequences of declaring bankruptcy.

argv_empty• 16 years ago

It's interesting to see the norm asymmetry (i.e. homeowners should just sit and take it) playing out in the Fool comments.

jerf• 16 years ago

One thing I don't feel the article addressed is that there is a range of being underwater, it's not binary. I bought after most of the deflation of value had occurred, but not entirely. I'm about 3-5% underwater right now. But abandoning my house (even if I was not concerned about the ethics) would still be bad, because percentage fees on getting a new one would eat my "savings" entirely. To say nothing of the beating my credit rating would take.

To really make it worth walking away you really have to be underwater by a lot. I don't think that 100% of the people who are underwater are down by 30% or 40%. Real statistics on that would probably be more helpful.

chrisgoodrich9• 16 years ago

I agree with this assessment. It definitely isn't a binary decision. Just as it isn't a decision that should be taken lightly. Obviously there are ramifications to abandoning a mortgage and all the risks and benefits need to be weighed based on every situation.

ajross• 16 years ago

Well, it's obviously true that it's not a step function. But the slope is really steep. Someone with just a tiny bit of equity can sell their home and walk away without having to pay anything. Someone with just a tiny bit of unsecured debt who wants to move loses almost nothing (a beaten credit rating for someone with income isn't nearly as serious as you think) by walking away, and saves thousands of dollars in fees (typical real estate fees in the US are 5/6%, and paid by the seller!). That may not be "binary", but it's pretty close.

The real determining factor in your case, I suspect, isn't financial but one of convenience. Finding a new home is a hassle, and you don't want to bother with it. It makes more sense to stay where you are because moving doesn't get you anything but grief. But if you got a great job in a different city, would you really be seriously thinking about trying to sell your underwater house?

liquidben• 16 years ago

"The real determining factor... isn't financial but one of convenience"

But convenience is financial as it can be valued. (My statements based upon extensive research involving 7-11 and getting food delivered)

geebee• 16 years ago

I think you have it exactly right. People with good incomes who are just a bit underwater on houses in San Francisco or New York should probably stay put. But people with low incomes who are hundreds of thousands of dollars underwater in the outskirts of Vegas... well, I actually think that for them, paying off the mortgage would be a financial disaster. It will take up every cent they own for decades, and they will retire broke. Seven years of bad credit pales in comparison to the severe damage they will do to their financial future by trying to pay off this house.

Personally, I think one of the reasons people hang on is that they're too optimistic about a recovery in prices. I'm sure prices on houses in the vegas desert will eventually start to rise again, but from $190k to 550K? Nope.

bd_at_rivenhill2• 16 years ago

One issue the article ignores is the damage to your credit. I would assume that having a foreclosure on your record would make it very difficult to get credit at a reasonable interest rate in the future, and that some of the people who continue to pay on a nonrecourse mortgage are accounting for the effect on the price of debt they may wish to incur in the future. I expect that this factor is ignored by economists because it is difficult to quantify.

prat5• 16 years ago

If there was someway to manipulate the way credit is damaged by looking at individuals so that only sub-prime borrowers are punished - that would be a possible solution. Let the responsible buyers walk away without penalty. But I understand that this has a potential for regime change and is far fetched in our situation.

bd_at_rivenhill2• 16 years ago

From the perspective of lenders, who are the people that credit scores are supposed to serve, this would be counter productive. Anyone who fails to pay a debt, for whatever reason, should be penalized. For large lenders, the underwriting decision is now almost entirely statistical, which provides them with lots of operational leverage (but is also one of the reasons that the bubble was allowed to inflate in the first place). If you want someone to make an actual underwriting decision, you need to go to a smaller bank or credit union. You will also find that many of these institutions weren't hit as hard because they made better decisions about what loans to make, and they sold off the poor quality loans that the government forced them make to the secondary market to avoid the hit when they went bad.

ams6110• 16 years ago

Successful capitalistic democracy requires a moral foundation. Many things that are arguably "in the best interest" of an individual are not in the best interest of a functioning economy, and not honoring one's agreements is one of these. The fact that corporations are not being ethical does not justify on a moral basis the same behavior by anyone else.

Further, if the coming predictions of high inflation turn out to be correct, the people who are still holding their mortgages will be paying them back with cheap dollars vs. people who walk away from their current debts and then need to borrow again later.

kls7• 16 years ago

> The fact that corporations are not being ethical does not justify on a moral basis the same behavior by anyone else.

That is the beauty of Morals and ethics, is that groups of people subscribe to different ones just as you say it does not give them the right. Other subscribe to an-eye-for-an-eye morality.

I personally think that it does justify it, my moral compass says that if a cooperation is abusing the people via deception, unethical and immoral behavior then that corporation should be dissolved and all debts to that corporation should be terminated. covering it up their appalling nature with a double ethical standard just emboldens more corporations to engage in unethical behavior and allows more abuse of the people.

Let me be clear, I am not anti-corporation, i am just anti-double standard.

dkimball• 16 years ago

The Motley Fool seems to have forgotten this, but rational-agent theory is a useful fiction, not a statement of reality. The best analogy I can think of is Skinner's behaviorism; rational-agent theory seems to fail in the same kinds of places as behaviorism does, too.

Look up the "Ultimatum Game" for a particularly effective demonstration of where it fails -- and the commenter here who points out that rational-agent theory would destroy civilizations is completely correct. (Mental exercise: apply "the tragedy of the commons" to a defensive war.)

petercooper2• 16 years ago

Why Are People Who Pay For Porn Idiots? Why Are People Who Pay For Music Idiots? Why Are People Who Don't Sell Drugs To Make Lots Of Money Idiots?

Because some of us have pride and morals.

prat5• 16 years ago

thats okay - but this is like paying for music/porn to be taken away from you. A big part of the equity you got when you signed up and paid for has been taken away but you are still paying the full price!!

pyre4• 16 years ago

Nothing has been 'taken away' from you. Someone lent you $X to buy something that you thought was worth $X. The value of what you bought has gone down, it's now worth $(X-Y). The bank didn't do this. They lent you $X and you're paying them back for that $X at the interest rate that you both agreed on.

Cars notoriously devalue over time. Are you saying that the bank is stealing money from you because you new car dropped 10% in value the moment that you drove it off the lot, but you are still paying the bank for a loan of 100% of the original value of the car?

pyre4• 16 years ago

It's not like walking away from a mortgage gets you off scot-free. The entire point of a mortgage is that it's a contract. If walking away from the contract and enduring the penalties associated with doing so is less financial pain than keeping with the contract, then why not?

It's not like these 'underwater' people are going to immediately move to some island in the Caribbean with bags full of money and sit on the beach in the sun living the good life until the end of their days while the poor, sickly bank dies alone and impoverished in a gutter somewhere.

petercooper2• 16 years ago

Yes, all technically true, but some people have pride or ethics issues with breaking contracts (social contracts being an even stronger example than mortgages..).

rleisti• 16 years ago

While reading this article, I felt there was as strong connection to this one (recently posted on hacker news):

http://www.economist.com/sciencetechnology/displayStory.cfm?...

...which basically says that entitled people in positions of power tend to hold others to a higher moral standard than themselves.

kscaldef2• 16 years ago

This article is remarkably oversimplified.

First, the obvious: once you ruin your credit rating by defaulting on your mortgage, it might not be so easy to just waltz right into a lower price rental. Not to mention that you'll be paying more on any other loans you take out for the next <strike>10</strike> 7 years, and probably your car insurance. You might also consider the increasingly common phenomenon of employers running credit checks on applicants.

There are a variety of legitimate factors in a decision like this which aren't purely financial: the time, emotional, and social costs of moving. Do you move your children to another school? Do you take your children away from their neighborhood friends? Perhaps you like your neighbors as well, or the neighborhood businesses you frequent. If you move into a rental, you can no longer make certain changes to your home to suit your needs and desires.

It's naive and insulting to call people "idiots" because they aren't simple money-maximizing machines, particularly if you're going to pretend that monthly housing cost is something that exists in a vacuum.

pyre4• 16 years ago

> Not to mention that you'll be paying more on any other loans you take out for the next 10 years [...]

I thought that bankruptcy came off your credit score/rating/listing after 7 years.

chrisgoodrich9• 16 years ago

It does. After 7 years a bankruptcy should not show up on your credit report.

kylec• 16 years ago

Maybe people like the house they're living in? Everyone seems to be talking about the financial side of things, but isn't it likely that many of the people still paying their mortgage do so because they like where they're living and don't want to be foreclosed on?

adharmad• 16 years ago

Exactly.....something that i never understood in all these articles is this: If I have bought a home for living in it, and not for speculation, how does it matter what its market price is? I knew _before_ I bought it what I will be paying the whole way and I don't want to sell it.

chrisgoodrich9• 16 years ago

Absolutely. I think this is the root of why most people do continue to pay their mortgages. If you can afford the payments and are satisfied with where you live, then there is no reason to abandon your mortgage.

Then there's the other group who (a) can't afford their mortgage anymore or (b) want out. This is the group who should evaluate this as a financial contract and evaluate the risks/benefits of abandoning the mortgage.

chengas123• 16 years ago

But you're not going to be living there for the entirety of your 30-year mortgage in most cases. What happens when 5-6 years from now, you want to move, but you're underwater and can't pay off the mortgage by selling your house?

lanaer• 16 years ago

If you're able to afford the payments, and are otherwise financially stable, I'm not entirely sure how another 5-6 years will worsen things.

Unless the economy manages to crash again in that time, and worse. Then, though, you'd probably be in a crappy situation even if you left now.

More than likely, at this point, your house will be worth more (though probably not a lot more) than it does now, and (since you've been meeting your payments) your debt will have shrunk, too.

kls7• 16 years ago

My personalty belief is that it will be 15 before prices recover to the peak in some areas, and if I where in a situation where I would need to relocate in five, I would take the hit now so that I would be on the road to recovery. Hell if most had did it in 06 they would most likely be able to get a mortgage (albeit at a higher interest rate) by now.

Specifically, Vegas, Arizona or Florida I would have had to do some soul searching , if I where not going to be there for over at least 10 years.

njharman2• 16 years ago

As a recently newly minted homeowner who paid appropriate price in a non-bubble market I find the title highly offensive and hyperbolic. "Why are underwater homeowners idiots" is the appropriate title.

Re: article itself.

There's also the small matter of jacking your credit for 7 years. With uncertain future and no savings many people rely on access to credit for emergencies. Not saying that is wise or that they should, but that is a fact.

DenisM3• 16 years ago

Assuming you took out a mortgage, you are financing consumption by leveraging up. It's no different than buying a pack of beer on the pay-day-loan money. Not a financially smart move (unless your loan interest rates is below the long-term treasury rates).

njharman2• 16 years ago

house != pack of beer

tax deductions, appreciation, equity, income(it's a duplex and I rent 1/2), plus all sorts of small things such as reduced auto insurance as it's rolled into home owners insurance

axod3• 16 years ago

Can you put a [US] tag in the title. It's not really relevant in other countries.

Also a slightly less inflammatory hyperbolic linkbait title would be good.

colomon• 16 years ago

It sounds like a small thing, but I'm glad just to see an article which doesn't just assume that people who are underwater were foolish or reckless buying a house in the first place. I bought well within what I could afford in 2001, and routinely paid down extra principal every month. Now that I am married and have a small child, I'd like to move someplace bigger, nicer, and closer to the rest of my family.

Only thing is, according to the real estate agents, if I'm really lucky selling my house will just cover what remains on the mortgage. If I'm not lucky, selling the house could easily cost us $20,000. Crazily, the most likely reason for that to happen wouldn't be that we couldn't find someone to buy the house for what we'd like to sell it for -- it would be that we couldn't find a lender to appraise it for that much.

Personally, I haven't sussed out the moral implications of just giving the bank the house instead of paying back the loan. On the one hand, it's hard to see how the bank could complain: yeah, they might be getting a house valued at $N in lieu of $N + $20,000, but they also got 8.5 years of interest on it, too, which probably amounted to around $45,000. On the other hand is the notion that implicit in our loan contract was the idea that we would pay it off if humanly possible; that allowed the bank to lend us the money for less than would have otherwise been possible. I don't know how to balance those two things.

chrisgoodrich9• 16 years ago

In my opinion, you are the prime example of whom this article is discussing.

In my view, the bank will still profit off of your loan. If market value is about equal to what you owe, but it could only be reasonably sold for $20k but you have paid $45k in interest thus far, they still profit $25k from your loan. I have a hard time seeing where the bank could be morally right in damaging your credit for walking away...

Why Are Homeowners Idiots?

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