Wednesday, January 06, 2010

Why you should walk away from your mortgage

Megan McArdle argues that underwater homeowners should continue to pay their mortgages, and not "ruthlessly default" by walking away if they can continue making their mortgage payments. She argues that the social norm to honor debt are important to a well functioning society, and if this norm was eroded we would all pay through higher interest rates etc.

I disagree. In the context of the credit bubble, banks made loans to customers who could not service that debt out of income. It was a two way bet on rising asset prices. Since that bet did not work out, the borrower should walk away, and the bank should write the asset down. If the loan had been made on the basis of income, then I would agree with Megan.
Waldmann, and I think Salmon, view the tightening of credit as a feature rather than a bug, of course--they'd like to return to the days of paternalistic credit markets
Waldmann and Salmon want to return to the days where banks made loans that would be paid back. This is not paternalism, this is Sanity.

Amazingly, Megan has managed to write a post on the credit bubble without realizing there was a credit bubble at all.

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