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In an article published by the New York Times Saturday, Jan. 23, 2010, economist Richard Thaler suggested that many borrowers might be far better off if they just hand the keys back to the bank, stop paying their mortgages, and walk away from their homes.
Thaler, who currently teaches at the highly regarded University of Chicago Booth School of Business and is an associate at the National Bureau of Economic Research, regularly consulted with President Barack Obama’s top economic advisors during the 2008 presidential campaign.
Professor Thaler is well known as an expert in behavioral finance and collaborated with Professor Daniel Kahneman prior to his winning the Nobel Prize in Economics. Kahneman gives much of the credit for the award to Richard Thaler, saying that much of the key work was done by him.
In his article, Thaler asks, with millions of Americans underwater on their mortgages, “Why is the mortgage default rate so low?” Those individuals owe more on their mortgages than their homes are worth so there is a tremendous incentive for borrowers to “strategically default” on the loans.
In many local markets around the country, real estate values may still be down 50% from the peak. In Florida, as many as 40% of all homes are considered to be underwater. And there are less desirable areas where foreclosures are still rampant. In those markets, prices are down as much as 80% or more from the inflated values experienced at the peak of the market.
A homeowner in the lovely area of
Yet many borrowers continue to pay the loans, at least partly due to a moral decision. Thaler notes that this moral choice has been influenced by government officials like former Treasury Secretary Henry Paulson, who while in office said that anyone who could afford the payment but chose to walk away from a mortgage would be “simply a speculator — and one who is not honoring his obligation.”
Strange that Paulson spared Wall Street banks and brokerage houses from his moral outrage, even though lenders adopted lax underwriting standards to get as many loans approved as possible, then that “debt was packaged and sold to investors who bought mortgage-backed securities in the hope of earning high returns.” Then lenders took leverage, in some cases they borrowed $35 for every $1 they had, which added more risk to the banking system that they later decided to pass on to the American taxpayer.
35 to 1. Was it really such a surprise that it would end this way?
When the mortgages began to default at a higher rate than expected it kicked off the banking crisis that almost collapsed the entire Financial System. 8 Million jobs have been lost. The Federal Reserve has been forced to use taxpayer money to buy over $2 Trillion of bad assets during the banking bailout. The federal government deficit is $1.3 Trillion, reported today, and now that the system is stabilized, the banks are now booking huge profits and paying executives billions of dollars in bonuses.
To quote Professor Thaler, individual borrowers “think they are obligated to repay their loans even if it is not in their financial interest to do so, while their lenders are free to do whatever maximizes profits. It’s as if borrowers are playing in a poker game in which they are the only ones who think bluffing is unethical”.