Some years ago, we decided to cover up a small indoor swimming pool (don’t ask) in our home in Bethesda, Md., and turn it into a sunroom. The cost was about $25,000 and, although I tend to be averse to debt, we applied for a home equity loan to pay for the renovation. We had, by my reckoning, a couple of hundred thousand dollars of equity in the house, perhaps a bit more. So we asked Bank of America, our mortgage holder, for a home equity line of credit for $25,000.
No problem, said the banker who called me back. We’re giving you $250,000. Assuming that an extra zero had been added to the loan amount by mistake, I told him we’d asked for $25,000. Yes, the banker said, but we’ve qualified you for $250,000, and so the line of credit will be $250,000. You’re under no obligation to use it, he added, unnecessarily.
Is this predatory lending? Carelessness? Rational behavior? Or some mix of all three?
Regardless, we know now that banks across the country were acting the same way–throwing money at some people (like us) who didn’t want it and at others who would soon prove unable to pay it back. I’ve read and thought a lot about how and why this happened; my three favorite accounts are Michael Lewis’s The Big Short, the radio broadcast The Giant Pool of Money by Alex Blumberg and Adam Davidson, of NPR’s Planet Money fame and a paper and podcast from economist Russ Roberts of EconTalk called “Gambling with Other People’s Money: How Perverted Incentives Created the Financial Crisis. All are eye-opening and fascinating–I kid you not.
The housing meltdown is, needless to say, still with us today. It’s the single biggest reason why millions of Americans are unemployed, people aren’t spending and the economy remains choppy, at best. It’s also a cause of what, at the risk of sounding like a fuddy-duddy, looks to me like an erosion of moral values, as many thousands of borrowers simply refuse to pay what they owe.
Under the headline Debts Rise and Go Unpaid, as Bust Erodes Home Equity, The Times reports today that delinquency rates on home equity loans are soaring, in part because people choose not to pay them back:
The delinquency rate on home equity loans is higher than all other types of consumer loans, including auto loans, boat loans, personal loans and even bank cards like Visa and MasterCard, according to the American Bankers Association.
Lenders say they are trying to recover some of that money but their success has been limited, in part because so many borrowers threaten bankruptcy and because the value of the homes, the collateral backing the loans, has often disappeared.
…Lenders wrote off as uncollectible $11.1 billion in home equity loans and $19.9 billion in home equity lines of credit in 2009, more than they wrote off on primary mortgages, government data shows. So far this year, the trend is the same, with combined write-offs of $7.88 billion in the first quarter.
Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar.
According to the Times, borrowers say they can’t or won’t pay for a variety of reasons. The banks were careless lenders. The banks got government bailouts. Their homes have lost value. And, most of all, they know they don’t have to pay. They threaten to declare bankruptcy–the term of art for this is a “strategic default”–and offer the banks a fraction of what they owe. The paper quotes a Phoenix lawyer named Marc McCain, who represents hundreds of borrowers:
“People want to have some green pastures in front of them,” said Mr. McCain, who recently negotiated a couple’s $75,000 home equity debt into a $3,500 settlement. “It’s come to the point where morality is no longer an issue.”
Yes, it has. Just as it was rational for banks to heedlessly make loans during the housing bubble because they weren’t going to hold onto the loans for long, it’s now rational for borrowers to walk away from their obligations, simply because they can. But being rational doesn’t make it right.
After all, someone will pay because so many loans have gone bad. It may be our children, and other new home-buyers, who will be charged higher mortgage interest rates in the future because the banks anticipate more “strategic defaults.” It may be small businesses that find it harder to borrow money to expand and create jobs. It may be anyone who wants credit card or an auto loan, and can’t get one as lenders recognize that fewer and fewer people feel obliged to pay what they owe.
Worst of all, it may be American taxpayers who are left holding the bag because of all the money the government has spent propping up the housing market and bailing out failed banks.
This would be the worst outcome because we don’t want to socialize the losses in a profit-and-loss system. Without the fear of losses, after all, there’s no reason for either banks or borrowers to act prudently. They can take risks and know that someone else — namely the taxpayers — will rescue them.
Besides, I don’t mind paying for our sun room–we’re really happy with it–but I hope you understand that I’d rather not pay for yours.