Walking Away From Negative Equity

For millions of Americans with 'underwater' mortgages, sending the keys back to the bank could be the cheapest option

It is probably best to leave the gods out of discussions of economic policy, but this barrier was breached in November when the CEO of Goldman Sachs, Lloyd Blankfein, told an interviewer that Goldman Sachs was doing God's work. Most people will never have the opportunity to join Goldman Sachs's gang of multi-millionaire bankers. However, by Blankfein's logic, tens of millions of people will have the opportunity to do something at least as heavenly: walk away from their mortgage.

In Blankfein's assessment, by aggressively taking advantages of profit-making opportunities given to them by the government and the market, Goldman Sachs is accomplishing great good here on earth. That's a questionable view, especially given the extent to which Goldman has been able to use its political power to tilt the playing field to its advantage, but walking away from an underwater mortgage is one way in which normal homeowners may be able to both help themselves and the economy.

The logic is straightforward. As many as 20 million people owe more than the current value of their homes. In most cases they have little hope of ever accruing equity in their home. There continues to be an enormous glut of housing. Nationwide, vacancy rates are at record highs. Rents are actually falling for the first time since we have reliable data.

Also, temporary government supports in the form of extraordinarily low interest rates and the first time buyers' tax credit are about to end. It is virtually certain that house prices will soon resume their decline and will remain low for many years to come. This means that people who are underwater today are likely to be even further underwater five or 10 years from now when they plan to sell their homes.

Not only will people end up losing money when they sell their home, but many underwater homeowners are likely to pay far more on their mortgage and other ownership costs than they would to rent the same unit. We did calculations recently that showed that homeowners who bought near the peak in many bubble markets could easily save themselves more than $1,000 a month by renting equivalent units. This means that these underwater homeowners could be throwing out more than $12,000 a year in a desperate effort to keep up on their mortgages. Since most of these homeowners will never have any equity in their home, the mortgage check they send to the bank is money thrown in the garbage.

Many homeowners are concerned about foreclosure damaging their credit record. This is a legitimate concern, but credit issuers want to extend credit. They all know about the growth and collapse of the housing bubble. It is likely that a foreclosure during this period will be treated less harshly than during more normal times.

Not only would it benefit millions of homeowners to send the keys back to the bank, it would also benefit the economy. The money that homeowners save by not paying their mortgage is money that could instead be used to support consumption and boost the economy. If 5 million underwater homeowners saved an average of $10,000 each by becoming renters, this would free up $50bn a year for additional spending. This would have the same impact on the economy as a $50bn tax cut. If we assume a multiplier of 1.5 on these savings, the 5 million walk-aways will generate close to 750,000 jobs.

Unfortunately, the current policy from the Obama administration goes in the opposite direction. Rather than realistically assessing what is best for homeowners, the policy seems intended to do everything possible to persuade people to keep sending checks to the banks, even using taxpayer dollars as an inducement. It would be far better economic policy if they sought to get people out from under their enormous mortgage debt. This could best be accomplished by granting people facing foreclosure the right to rent their home at the market price for a substantial period of time (five-10 years) following a foreclosure. Such a measure would immediately provide housing security to the millions of families facing foreclosure.

This policy requires no new bureaucracy and would cost the taxpayers nothing. Of course, a "right to rent" policy is likely to be costly to the banks. This may explain why it does not appear to be on the agenda at the moment. After all, the money saved by homeowners is money lost to banks, and this figure could easily run as high as $100bn a year.

In short, homeowners who are seriously underwater in their mortgages should check the numbers. Walking away from a home may well be the best economic choice, and in such cases, it is also likely to be the best choice from the standpoint of the economy as a whole. This may not be advancing God's work, but if millions of people walked away it might educate Goldman Sachs and the rest of Wall Street bankers about what happens when everyone plays by their rules.

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