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Finance, News, Thoughts

Strategic Defaults And Altruism Can Only Take You So Far

Normally what would make an interesting blog post is the connection of two seemingly unrelated events. But that’s not happening today.

Instead we have two non-intuitive findings that remain just that … non-intuitive.

Our first discovery is a conundrum. Why don’t more people who are ‘underwater’ on their mortgages, and can’t get their lender to negotiate in good faith, just mail the keys back and walk away?

It’s even got an official name, “Strategic Default”.

A provocative paper by Brent White, a law professor at the University of Arizona, makes the case that borrowers are actually suffering from a “norm asymmetry.” In other words, they 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.

Our second discovery is even more startling. It turns out that humans may be ‘hard-wired’ for altruism. I guess if you step back far enough it might seem to guarantee our survival as a species. But it does sort of conflict with what we know about survival of the fittest. More confirmation that life is not only not easy, but it’s also confusing as hell.

After trying for a bit to reconcile these two discoveries into one comforting model that would make that great blog post I finally gave up.

It would have required us to believe that the solution to the mortgage crisis was coming in the form of altruistic bankers.

In Your Dreams

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2 thoughts on “Strategic Defaults And Altruism Can Only Take You So Far

  1. Underwater consumers expect:

    * Market to bounce back in a few years

    * Walk away will toast credit rating

    Therefore, they make an irrational decision to pay.

    Posted by Tom Rosenkranz | January 25, 2010, 5:48 pm
    • Tom,

      Yes. And if the market does bounce back then it will turn out to be a good investment. Especially in those cases where folks are working and have the money to make their payments, just as they did before.

      There is always the possibility that enough people start walking for one reason or another and a tipping point is reached. Then standards of behavior and credit ratings might change so that creditors have no choice but to negotiate their own ‘haircut’.

      Chances of that are slim but not zero, IMO.

      Posted by Bob Gelber | January 26, 2010, 10:28 am

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