Federal Legislatures Consider Punishing Strategic Defaulters

Confident that house prices would never stop rising, most Americans never bothered to check what would happen if they defaulted. After all, who would walk away from a house worth more than the mortgage states an article in City Journal.

The author proposes a simple solution to the problem of underwater mortgages. We envision a reform of the bankruptcy code that, in areas where house prices have dropped precipitously, would require lenders to give homeowners the option of resetting their mortgages to the current value of their houses. In exchange, the lenders would get 50 percent of the houses’ future appreciation. To keep homeowners honest—that is, to prevent them from doing minimal upkeep in the knowledge that they stood to gain less from a home-price increase—the capital gain would be measured based on an average of houses selling in the area, rather than on the change in the value of the actual house.

In another article on Strategic Default, the Wall Street Journal states Just as the House of Representatives wrapped up a debate yesterday on a bill to give the Federal Housing Administration added flexibility to shore up its finances, House Republicans introduced a provision to bar government-backed loans for borrowers who had strategically defaulted–walked away from their homes when they could still afford the mortgage payments. The measure passed without opposition on a voice vote.

The proposal is ambiguous and probably impossible to enforce, and it still has to pass the Senate. But it raises an interesting question: Should Congress try to legislate borrower behavior by withholding access to government programs?

Finally, in a recent piece, Donald Bisenius, states that we know from experience that foreclosures and vacancies drive down the property values of everyone else in the neighborhood. Thus, strategic defaulters, in effect, deplete the personal wealth of their neighbors. Get a critical mass of strategic defaults, and broader communities and regions become affected. Indeed, Economy.com, the analytic firm, recently said that more strategic defaults could tip a fragile housing market back into one of further price declines. Even more families harmed.

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