I was in Aspen last week when this New York Times article on strategic defaults among the wealthy went up. I wanted to respond to it then, but I was too busy running from panel to panel. Meanwhile, I see that Ross Douthat has used it for the opening of a column, this seems like a good opening to ignore Ross’s larger point entirely, and write the critique I wanted to write last week.
It’s not that I think that it is necessarily untrue that the wealthy are more likely to default on mortgages that they could pay. Indeed, I think it is probably almost definitionally true, at least the way I think of strategic default. To me, a strategic default is refusing to pay a mortgage that you could pay without severely limiting necessary life activities. A lot less of the income of the wealthy is directed towards those things–and no, I do not consider private schooling, or summer enrichment programs, to be “necessary life activities”. So the wealthy always have more room to cut back than less affluent people. Saying that someone in the bottom two income quintiles has “strategically defaulted” on their mortgage is an oxymoron, unless that mortgage is for something like $10,000.
So I’m sympathetic to the thesis. The problem is, you really couldn’t prove that thesis from with the very thin evidence offered by the New York Times–although that didn’t stop a lot of bloggers from pouncing. What we know from the article is that a lot of the high-dollar value loans are in default:
More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.
What we don’t know is that those defaulters could pay the mortgage if they chose. Their anecdotes don’t even back up that conclusion:
At one house, where the lender was owed $1.3 million, there was a couch out front wrapped in plastic. A woman said she and her husband had lost their jobs and were moving in with relatives. At another house, the family said they were renters. A third family, whose mortgage is $1.6 million, said they would be moving this weekend.
. . . In the middle of a workday, one troubled homeowner here leaned over his laptop at the kitchen table, trying to manoeuvre his way out from under his debt and figure out the next big thing.
His five-bedroom house, drained of hundreds of thousands of dollars of equity over the last 13 years, is scheduled for auction July 20. Nine months ago, after his latest business (he has had several) failed in what he called “the global meltdown,” the man, a technology entrepreneur, said he quit making his $9,000 monthly payments.
Do any of these people have adequate resources to keep paying their loans? For all I know, they do . . . but the New York Times offers no evidence of that. What they have is one rapper, a law professor who thinks that maybe rich people are more aggressive, and one cynical analyst. I don’t want to go all Tipper Gore here, but does anyone really think that the behaviour of musical stars are sound approximations of broad American values? And the best evidence our cynical analyst can muster is this:
“Those with high net worth have other resources to lean on if they get in trouble,” said Mr. Khater, the analyst. “If they’re going delinquent faster than anyone else, that tells me they are doing so willingly.”
From this, the author concludes “CoreLogic data suggest that the rich do not seem to have concerns about the civic good uppermost in their mind, especially when it comes to investment and second homes. Nor do they appear to be particularly worried about being sued by their lender or frozen out of future loans by Fannie Mae, possible consequences of default.”
This is just nonsense. The CoreLogic data tell you how many people are in default. They do not tell you how concerned those people are about the civic good, nor what may or may not be worrying them in those 3 am moments when they contemplate the wreckage of their housing dreams.
We don’t even know that these people have more resources to draw upon, as Mr Khater implies. All the data I’ve seen show that millionaires–aka “high net worth individuals” are not particularly likely to live in million dollar homes. Who are? People who live in areas with expensive real estate. And where is the expensive real estate? Why, often in the areas that experienced the biggest inflation during the housing bubble.
Those are places where homeowners are much more likely than the national average to owe more than the house is worth. And being underwater on your mortgage is very highly correlated with default–much more tightly correlated than the local unemployment rate.
This has often been advanced as evidence that strategic default is popular, but I’ve seen no compelling data backing up this conclusion. There are other reasons that being underwater makes you more likely to default. For one thing, it makes it quite likely that you took out a loan in the bubbliest years, when bankers were allowing eagerly encouraging people to take on too much debt relative to their income. For another, it means that if you need to relocate, get divorced, or have some sort of an income shock, you can’t take the otherwise obvious step of selling the house. From what I’m hearing, most banks won’t even consider a short sale until you’ve already missed some payments.
Shouldn’t people with million dollar homes have more resources to fall back on? Absolutely. The best you can say about people in that situation is that they were probably living beyond their means well before things got to this point. But the bubbly areas–especially California–were characterised by a grim competition in which the houses in the good school districts went to the people who were most willing to overstretch themselves. Those people didn’t build up a big reserve of savings that might allow them to meet the mortgage payments while they find a new job, because they were pouring everthing into securing the best possible education for their children.
And in some ways, people with those jumbo mortgages are less able to adjust in crisis. If your mortgage payment is $1000 a month, shaving $200 off a $700 monthly grocery bill and quitting smoking probably gets you close to halfway towards keeping the mortgage current. If your mortgage is $10,000 a month, and one spouse loses their job, no manipulation of other basic expenses will help much.
I’m still more sympathetic to anyone with a $1,000 mortgage who loses the house, of course. And I still think it’s more likely than not that the wealthy are leading whatever trend their may be in strategic defaults. But that’s just a hunch, because, like the New York Times, I don’t have any data to back up that belief.
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