The bank-owned resale of the Candlestick Point two-bedroom condo that newly elected San Francisco Supervisor Malia Cohen purchased for $581,500 in December 2006 before letting the bank foreclose (“It was underwater, so I let it go…“) has closed escrow with a reported contract price of $320,000, a 45 percent ($261,500) drop in value since 2006.
As previously noted, while the Chronicle reported Cohen’s January move from the condo, we reported the bank had actually foreclosed on the condo this past August, a few months before her election.
Great to have thieves as elected officials, isn’t it?
She’s only a thief if she tries to keep the property, and she walked away. Elections deliberately allow voters great breadth in choosing representation. It is interesting that the condo is only worth about half what had been paid. If the bank had done due diligence then this loan would never have been made, so the blame is not all with the overreaching would-be owner. The lingering effects of a balance sheet recession may cause us in time to wish that taxpayers had made up the difference as is often suggested.
Homeownership is a Privilege not a Right.
But what this should show Ms. Cohen’s electorate, is that she does not make sound judgements but rather as this shows enters into calculated situauation to better herself then when it does not go her way, bails.
Is this really the sophmoric leadership that this city needs? IMO no.
I’m sorry but this is just shameful behavior on the part of an elected official.
Mole Man, in an indirect way, she stole money from taxpayers, some of whom are her direct constituents. And she lied when she signed the mortgage contract promising to pay the money she borrowed. A contract to buy a home financed by a mortgage is just that, a contract. It is not some kind of ersatz financial derivative or put option whereby the buyer of a home gets the right but not the obligation to walk away from the mortgage if the underlying instrument (the home) goes down in value over time.
She didn’t put any money down, of course it was underwater. That doesn’t excuse the lender from their lack of loan underwriting, but that lack of due care on the part of the bank doesn’t make what Supervisor Cohen did any less morally reprehensible. If there’s any justice in the world she won’t be reelected.
What are you guys on about? She did exactly the right thing. A contract has consequences for breach. She weighed the consequences and came to the obvious conclusion. Why would you want to white knight the bank in this situation? They are getting what they deserve for their idiocy.
Not Bashing, Brahma: In my mind she made a sound financial decision in walking away. The contract states that if she stops paying, the bank takes the property. That’s exactly what happened here.
Assume the City owes $10 million on something which is a) not really needed and b) is now worth only $5 million. Further assume the consequences for walking away is that the lender takes ownership of this “something” – I saw it would be a crime against the taxpayers to _keep_ paying.
Would you guys really prefer an elected official who keeps pushing money down a black hole? Makes no sense to me.
It was the right decision to exert her contractual rights against the bank. It was the wrong decision to buy this house in the first place with ridiculous leverage and an obvious inability to pay. She screwed the taxpayers with the latter, not the former, and she doesn’t deserve to be re-elected for having bad judgment in the first place.
@ Falling,
I partially agree with you, but I feel she also shows a lack of care when buying something with other people’s money. In this case it was the bank’s, in the future it will be the city’s.
I don’t think Cohen did anything wrong by walking away. I do think she misrepresented the situation during her campaign for election.
Elected officials should be held to the highest standard.
A ding in your credit history could cost you a job during an interview, but it wouldn’t apply to people who claim to represent us and legislate in our name?
Seems like she didn’t simply “walk away”. If I’m reading it right, she “lived and slept away” for free for over a year. Then she walked.
The people who advance the notion that strategically defaulting on her mortgage was somehow the “right” thing to do because the bank offering the loan didn’t conduct proper underwriting either haven’t thought it through or have a highly impaired sense of right and wrong. I’ll concede that “a contract has consequences for breach” and that Cohen suffered the consequences of a breach; I’m not arguing the legalistic argument here, I’m discussing the moral one.
It was probably legal for Gavin Newsom to have an affair with his re-election campaign manager’s wife. However, most reasonable people would agree that it was the wrong thing to do.
Also, the people who are implicitly advancing the argument that the bank should have never made the loans in the first place and therefore should have to suffer the consequences of their poor loan underwriting are awfully naive. If the bank was so obviously stupid for loaning her the money in those circumstances, what that actually says is that it’s obvious that Cohen shouldn’t have borrowed the money. You simply can’t indict the bank for doing something obviously stupid unless you also indict Cohen.
Of course, that argument assumes that you don’t buy into the construction of a mortgage loan as an ersatz put option, whereby if the underlying instrument (the home) goes up in value, the borrower gets the proceeds of the deal, and if the instrument goes down in value, the borrower walks away and sticks taxpayers in general with the loss. This is one of the more pernicious notions promulgated by the libertarian commenters on this site.
Strategic defaults are not immoral.
Regardless of the morality involved, the industry is starting to make forward looking changes related to the increasing issue of strategic defaults.
FICO just put out a white paper with some info on strategic default that has some interesting info and also attempts to tout some of their analytic solutions for identifying potential strategic defaulters.
http://www.fico.com/en/FIResourcesLibrary/50_Predicting_Strategic_Default_2722WP.pdf
According to them, above FICO 620 people are more likely to be strategic defaulters then non-strategic. I’d assume that once the private loan market returns, this will encourage banks to require smaller CLTV’s and get better appraisals for higher end borrowers. Especially in non-recourse states a borrower’s high incomes and/or assets may not be adequate to protect the banks interests.
Also as referenced in the FICO white-paper, FannieMae last year instituted a 7-year lockout for strategic defaulters.
http://www.fanniemae.com/newsreleases/2010/5071.jhtml
“Of course, that argument assumes that you don’t buy into the construction of a mortgage loan as an ersatz put option, whereby if the underlying instrument (the home) goes up in value, the borrower gets the proceeds of the deal, and if the instrument goes down in value, the borrower walks away and sticks taxpayers in general with the loss. This is one of the more pernicious notions promulgated by the libertarian commenters on this site.”
That’s not a libertarian view, and I’m certainly not even close to libertarian in leanings, but rather an accurate statement of the law with respect to non-recourse mortgages in California. A non-recourse mortgage is by definition a put.
What would be a libertarian view is suggesting that “a contract is a contract” and you must stick with the contract no matter what (insert random ridiculous statements about property rights being sacred and taxation being theft by guns, just for good measure too).
I don’t think it was the right thing for her to walk away because the bankster was equally culpable, but rather, it’s the right thing to do because it made sense under the circumstances and it’s an exercise of her legal rights under the contract. If she breached the contract, she should face the consequences of the breach, and the appropriate remedy is to give back the house to the bank.
I don’t think anyone disagrees that entering into a stupid contract was stupid to begin with, but it’s strange to suggest that exercising legal contractual rights is wrong. The bankster was stupid for giving the loan in the first place too, but that doesn’t have any bearing on her culpability.
We need more representatives like this. She’s closer to the average person–who is more likely to be underwater on her property than the current crop of super rich politicians. She absolutely did the right thing by walking away–as was her legal right. Why should she make her family suffer so a bank can benefit? She is far from a thief.
I’m convinced if this was a rich white businessman that walked away from an underwater investment the people criticizing the counsel woman would be cheering on his astute business sense–as a black woman representing a poor district it doesn’t surprise me some call it “theft” (I’m reminded of those captions from Hurricane Kartina that described white people as “finding” food after the disaster while black people were “looting”).
To me it feels more like renting a place and having a call option to buy rather than a put. While it is ultimately semantics, with a put you have an option to sell it a set price (the mortgage balance) while with a call you have the option of buying the place at a set price.
Personally as the one holding the option, in my mind it translate easier into thinking that in 2017 I’ll have the option of starting to buy it, by paying principal, and until then my interest only payments are rent.
The morality argument, in my experience, is not really an honest argument but simply an excuse to screw average people over and to enrich the already rich.
The people that wax poetic about the sanctity of contract are usually huge flaming hypocrites. For instance, I doubt there are many loan morality preachers that also demand that the government honor its contractual obligations to the people or its employees. The conservatives, libertarians, and neoliberals that are most eager to screw over average people never talk about the sanctity of contract when talking about public sector unions, for instance. They never say, “well, we promised those workers they would have X retirment and we have a moral duty to follow through on our contractual promises.” No, they usually say that the government can’t afford to live up to these promises and that the responsible thing to do is for the government to use its “put option” and breach its promises to its workers.
Likewise, these people are probably the first ones that want to break promises to the American people when it comes to Social Security and Medicare. People have been paying into these programs and were promised certain benefits and it’s funny how the morality police on the right won’t ride in to talk about the sanctity of contracts when it comes to Social Security.
It’s a one way street–they care simply about rigging the game so the rich get richer on the backs of average people. In this case they want corporations to make ruthless business decisions precisely when real people’s lives depend on it but want the people to screw themselves over out of a sense of morality towards an immoral corporation.
I agree. We need more people like Cohen to lead us all to show the right path. Everyone who is underwater should strategically default like our great leader Cohen.
Cohen for President, and after that IMF president.
Actually, I would prefer an Icelander for IMF president.
Having an average person in office is a benefit, not something to be shameful about. I prefer her to someone like Gavin Newsom who also bought in the last 5 years and probably lost a ton of equity but he’s so rich he doesn’t have to worry about it so he wasn’t faced with a similar moral choice.
And everyone that is crippled with underwater housing debt should absolutely walk away. That is the best solution under current circumstance to the problem.
Even better would be for the federal government to nationalize the banks and to write down all mortgages to their current value and wipe out all unsecured debt. We shouldn’t be propping up dead banks and kicking the can down the road. We are simply creating a drag on the whole economy–where real people will suffer the most and the banksters will walk away with all the dough.
“Having an average person in office is a benefit, not something to be shameful about.”
Seriously? I never understood the rationale for voting based on “I’d like to have a beer with that person.” If we’re handing someone the nuclear launch codes, I want that person to be far better than average in intelligence! Even lowly Board of Stupidvisors members should be smarter than average, but they’re not, and that’s why we had Chris “It’s on like Donkey Kong” Daly.
Well, I don’t equate being rich with being intelligent. I also don’t equate someone in their 30s (or thereabouts), who bought a home in the SFBA in the last ten years, and is underwater, with being unintelligent or otherwise not being savy, etc. There are tons of normal, perfectly responsible, intelligent people, that are underwater on their homes. It does not make them bad people or disqualify them from office (although the reverse would be true for and demonstrated superior financial judgment should be rewarded). In fact, wasn’t Obama himself underwater or stretching to get in his home (before he became a Senator and got filthy rich)?
Getting filthy rich is usually the reward for serving corporate interests while in office. Or often times it’s the prerequisite. It’s refreshing for me to see normal people with normal incomes and normal problems running for office. I trust them much more than the “super intelligent”, best of the best, rich guys like Gavin Newsom.
Oops. I flubbed the best line:
. . . the reverse would be true for those that demonstrated superior financial judgment and rented during the Great Housing Bubble–those like Chris Daly. Ha.
I agree with SFHawkguy on one thing: there’s no moral issue here – Ms. Cohen shouldn’t feel any pressure from any “moral suasion” sort of argument. I’m actually shocked that commenters in SF resort to “morality” arguments, when so much of the acceptable code of conduct in SF would have been considered “immoral” by probably the overwhelming majority of societies and civilizations throughout history.
Now, if she had actually put any of her own money at risk in this condo, I’d agree she’s unfit for public office. Only a total fool would have thought Candlestick Point was worth $600k in 2006. Down 45% since then is probably not enough – I hope the new “owner” got an FHA loan and put down less than 3.5%!
Seems like we’re talking about two different things. You’re saying “average” in income — I’m saying intelligence. I think I misconstrued “average” as meaning “average in all ways,” whereas I think you meant “of average income.”
I respect the difference of opinion here, but to me this is cut and dry. Purchasing a property always has an element of speculation – at the very least, you hope not to lose money. It should be an investment decision, like any other. If it goes up, you are rewarded. If it goes down, you’re penalized. This “just walk away from it” attitude is ridiculous. There is nothing wrong with speculation – I’m a professional speculator myself – but do it with your own money and when you lose, you lose. If i make bad trades, i lose money. Take some responsibility, don’t leave the rest of us holding the bag.
Not Bashing, assume you made a speculative play in your field, and your counterparty agreed, for some reason, to a contract that said you could keep any gains but walk away from any losses, and the deal tanked spectacularly. Wouldn’t you feel fine saying “a deal’s a deal” and walking away?
Don’t hate the player. Hate the game.
“Wouldn’t you feel fine saying “a deal’s a deal” and walking away”
But don’t you think that the loss this person inflicted on the taxpayer should at least be factored into future government credit guarantees on their behalf? i.e. Encourage lawmakers to have the FHA follow Fannie’s lead and lockout strategic defaulters for at least 7 years?
tc_sf, absolutely. I think that should apply to all defaulters, strategic or not.
“Encourage lawmakers to have the FHA follow Fannie’s lead and lockout strategic defaulters for at least 7 years?”
That’s a great idea. If you could only convince Congress… However, you also need to convince Congress and the Fed not to bail out moron banksters who deserve to get fired.
Until that point, if the bankster is willing to sign up to a crappy contract in a non-recourse state, it’s fine for a mortgagor to take advantage of that contract. Even if you’re going to say “a deal’s a deal,” the bankster also agreed to a crappy contract. The bankster is free to lobby the state government to make mortgages recourse.
@ A.T. – I understand your point – truly – and I do take issue with the game. However, I also take issue with a public official – someone who is supposed to help improve the game – playing it this way. As for the banksters, of course they are happy to take the other side of that deal. They just sell it six weeks later, no risk for them. Both (original) sides are shirking their responsibility in this scenario. A.T.’s point is well taken – the game is the main problem – but I have to take issue with elected officials who are happy (proud?) to have worked the system this way. She could have just continued to live there, there was nothing “forcing” her to walk away. If she took office in the city, she clearly did not have to relocate for a job or a family crisis.
@ whoever it was that played the race card – I don’t even know who this politician is, so clearly I wasn’t aware of her ethnicity. Try to stick to talking points instead of name calling, if you want anyone to take you seriously.
Fair enough – I understand holding public officials to a higher standard. That’s how it should be.
@ Basher What’s His Name,*
The post describes her buying a condo in Candlestick Point and her name as Malia, and you made no association as to her ethnicity when you called her a thief, eh? You sure about that? You don’t associate that area or the name Malia with any ethnicity? Do you call all people that default on their loans thieves? And I’ll even grant you that it may have been unwitting.
But there it is: You are calling one of the few black female politicians in this City, someone from one of the last distinct black communities, a thief. I don’t normally hear this said about white folks that default so it struck me as being related to her race and where she lived. Many conservatives have claimed that the Community Reinvestment Act was the cause of the housing problems (read: giving black people loans). many people on this site have issues with this part of the City. This sure sounded like that type of a critique and while it bugs me when people make a moral argument about defaulting it really bugs me when people make a big deal out of black people defaulting. Maybe you aren’t a full fledged conservative housing racist but you are treading on that territory.
And where do you get she is “happy” or “proud” of this? Most people that default on their homes never intended to default and it is not a pleasant experience. Do you have any basis in fact to so speculate? And do you have any idea how hard it would be for someone of average income to work their way out of a $261,000 hole? You make it seem like it would have been painless for her to work her way out of this hole and you seem like you have no idea about her specific situation (aside from your bigoted assumptions), nor what is required of the typical person in this situation.
* Nice try diminishing me by not acknowledging my name. For such a clever guy it makes it even harder to believe that you weren’t associating a Bayview condo that is owned by Malia and went into foreclosure with a black woman.
“However, you also need to convince Congress and the Fed not to bail out moron banksters who deserve to get fired.”
But by your logic why is the banker doing anything wrong? If the government is willing to either explicitly or implicitly take on the credit risk for little or no cost why should the banker spend much time and or money worrying about it.
If your credit card company provides you with free flight cancelation insurance would it make sense for you to spend a great deal of time analyzing the airlines financial condition to ensure that they won’t go bust between the time you buy your ticket and take your flight?
Not Bashing,
Housing should not be a speculative investment. Housing is for living in. Deregulating housing so it could be traded as a speculative investment was a major part of the problem. You just whoooshed right on past the banks’ culpability in your effort to blame it all on the home buyers (the banks will just sell it to someone else in 6 weeks anyway).
The banks were in violation of the rules and if we were playing by the rules many banks would have gone into bankruptcy and sued or imprisoned for fraud and lots of lucky duckies would have free homes because the banks messed up recording title. But the rules were suspended when it turned out it would hurt the banksters too much (no bankruptcy for them). Just as you want to ignore the rules that help the home buyers (the ability to default in non-recourse states).
You are not really making an argument for changing the rules so they are more fair–you seem more concerned with punishing one player in the game and lifting the rules for the other player.
tc_sf,
The banks may have violated the laws by knowingly creating or participating in fraudulent underwriting standards, pushing people into more expensive loans, or making misrepresentations to those that purchased securities.
The government was certainly to blame for deregulating banks and allowing securitization and guaranteeing loans with weak underwriting (and following the private sector’s underwriting standards).
So yes, the banks are greedy pigs and the government was foolish to expect the greedy pigs to be anything other than greedy pigs.
“The banks may have violated the laws by knowingly creating or participating in fraudulent underwriting standards”
But even now the government run FHA is allowing down payments as low as 3.5% with 3% seller concessions. During the boom the FHA allowed 6% seller concessions. During the boom the government also sanctioned down payment assistance programs which could further reduce or eliminate the need for the borrower to bring cash to the table.
If the government ran and is still running low/zero down loan programs it seems hard to argue that banks went against public policy by creating underwriting standards that in many cases were higher then those of the government run FHA.
El Bombero wrote:
In case it’s not obvious, the existence of the 30 year self-amortizing non-recourse mortgage hasn’t existed during “the overwhelming majority of societies and civilizations throughout history.” We have them because of a certain amount of direct government intervention in the marketplace, legislation, and tradition and mores and social norms that are fairly recent.
And the tradition, mores and norms part is important, because during the the overwhelming majority of the history of the self-amortizing mortgage in this country, people didn’t treat a mortgage as an ersatz put option where they could blithely walk away from a loan obligation if the underlying instrument’s market value went down and stick taxpayers with the bill.
During the overwhelming majority of the existence of said mortgages, if a borrower signed a note, they did their level best to pay it off unless they had no choice or weren’t able to. And certainly elected officials took their responsibilities seriously.
Think about it this way: if, because the actions of Ms. Cohen and other strategic defaulters like her cause so much damage to mortgage lenders, most American banks in the near future start requiring 30% down payments, a lot more people will be priced out of the housing market than are priced out right now.
Those people, many of whom live and vote in the 10th Supervisorial district and were honestly scrimping and saving up for a down payment during the credit bubble waiting for home prices to return to pre-bubble levels, weren’t party to Ms. Cohen’s “deal” that A.T. analogized above at 4:47 PM, but they were (or will be) harmed at least twice:
• their taxes will be used to cover this default in one way or another (btw, I haven’t heard one even remotely convincing explanation from the folks who think that the “stupid” bank should be “punished” for loaning Ms. Cohen 100% of the purchase price how such market discipline will actually be meted out to an institution with access to The Fed’s discount window).
• they won’t be allowed to take advantage of the terms that were available to qualified buyers just a few years earlier, because too-slick “deal” makers like Supervisor Cohen decided it’d be “smart” to stick others with the bill for loans that they decided it would be inconvenient to repay as they contracted to do, and so lenders will have to change the terms of commonly-available mortgages in order to head off future losses.
This is not even getting into what happens to other owners in the complex who now have a highly negative foreclosure comp to deal with.
There’s many reasons that most commercial mortgages taken out by companies have significantly stricter terms than a 30 year self-amortizing residential mortgage. One of them, as I understand it, is that a corporation getting a commercial loan can default a lot easier than a residential owner-occupier can due to limited liability. The strict terms are in response to the increased risk, no?
One “moral” aspect of this comes into view more clearly when you realize that Ms. Cohen decided to hurt other people, including many of her own direct constituents, who weren’t parties to the contract she signed when she decided to strategically default because a home she bought with no money down was worth less than the loan amount. When, as a result of your selfish actions, you cause harm to other people, that makes you immoral.
I realize that libertarians won’t accept this line of reasoning, because they see the mortgage contract as being between the lender and the borrower and no one else can ever be harmed because only two parties are involved. If your goal is to “rip the face off” the other party to a trade because that’s how you prove you’re smart, then the moral myopia is quite understandable. But that’s not quite how the real world works in this case. There’s no way to limit the damage that Cohen caused to the loan officer that approved this mortgage package or even the stock holders of the specific lender that loaned her the money, and if she didn’t know it at the time the loan was made she certainly knew it when she defaulted (and if she doesn’t know it now, that alone proves she’s unfit for public office). I don’t expect that someone elected to The Board of Supervisors would operate with the morals of a trader or other wall street shark.
I actually agree with SFHawkguy, above, that the morality argument is usually not put forward honestly, but in the case of this elected official who should behave better, I think she should be run out of town on a rail.
Brahma,
What evidence is there that she chose to walk away? Do we know her exact financial situation, her other commitments or her household expenses, do we?
Most people don’t have the income to pay the loans off when it recasts into a normal 30 year amortizing loan. Sure, they were foolish for taking the loans out. They were unsustainable and couldn’t be serviced. But the banks gave them these loans and the banks and regulators bear more culpability in underwriting them then average people do. It’s human nature to want to stretch financially to get into a house. The reason people haven’t historically had to use the put option is they have never been as silly upside down as people are now (in addition to other debts and costs being harder on the average household).
So I agree Brahma that it is a societal problem. But you’re looking at it from a different angle. We need to free people up from this leveraged debt that they can’t sustain. We need to free the debt slaves and restore basic government regulation that keeps housing prices lower and tied to a reasonable multiple of income. We don’t need to reinvent the wheel.
And as far as wondering how to punish banks that feed at the Fed’s trough (er window), how about we take the piggies away from their free meal? Or nationalize them. Or put them in bankruptcy.
tc_sf,
Good point. Some banks followed engaged in strict underwriting and the government did loosen its underwriting as well.
But did the government back no doc loans? Liar loans? My understanding is that this was mostly private label that did that. That comes closest to encouraging fraud because it was a clever way to encourage fraud but for all the participants to maintain plausible deniability.
But I actually think that stricter underwriting helps society by keeping housing prices lower. It also helps individuals by ensuring they can afford the debt (human nature is to stretch and that’s why we have so many liar loans).
I’m stunned that people are bringing up morality here. That shipped sailed a long time ago!
Ms Cohen clearly made the right decision…as AT mentioned, don’t hate the player hate the game.
SFHawkguy, I agree with what you wrote at 10:50 PM that housing should not be a speculative investment, it should be for living in, and that’s why the recent conception of a home and mortgage combination as effectively a put option kinda irritates me. All the laws we currently have on the books related to homes and mortgages, including the non-recourse nature of mortgages in this state, weren’t put into place to facilitate the trading of put options, they were put into place to facilitate people buying homes to live in.
People with the mentality of traders (see A.T.’s invocation of “Don’t hate the player. Hate the game”) don’t seem to get that. I expect an elected official to get that.
My evidence that she chose to walk away is that she told a reporter that “it was underwater, so I let it go.” That’s enough evidence for me that she decided to strategically default.
Of course she was underwater! She didn’t put any money down. She should have expected to be underwater, and for quite some time at the outset, and if she didn’t understand that beforehand, she never should have signed the loan documents. The black hole that “Falling” says her money was being pushed into above was entirely of her own choosing. She wasn’t along for the ride, she was Doctor Hans Reinhardt, steering the USS Cygnus directly into the black hole, knowingly.
Your point about increasing the overall societal good by freeing people up from debt-slavery is one that I agree with (and I agree with most of the rest of your comments conceptually), I just don’t think we can get there by applauding strategic defaulters and describing them as doing “exactly the right thing”, as dylar did above. In theory, I agree that we should have nationalized failing and zombie banks in 2008, but given that people think President Obama is a socialist for trying to get a marginal increase in the number of people with access to health insurance I think it’s safe to say that the Tea Partiers would have gone apoplectic if the Treasury had taken ownership in the banks.
BIR: You honestly don’t know the motivation of Ms Cohen’s purchase of the condo in question. She may have done so for entirely speculative purposes, or was hoping to live in the unit for a long time, or perhaps a combination of both.
My reference to AT’s quote about “…hate the game…” does not refer to having a mentality of housing as just another instrument for trade but rather the system of laws we have in the United States. (That is the game!)
So she breached the contract? Big deal. It happens every day. Circumstances changed dramatically and she made an informed decision that the consequences of breach were better than continuing to pay her mortgage. The “she should never have signed the loan documents in the first place” argument is naive. (It’s kind of like leaving a bad relationship.)
Are there negative outcomes to society as a result of her decision? Absolutely. But don’t confuse that with her decision being valid and perfectly legal.
@ SFHawkguy – I agree with a great deal of what Brahma is saying, but to put a finer point on it consider the following.
Morality, like taste, does not yield itself to having only one “right” answer. But consider that the moral system exhibited by Cohen here does not yield the outcome that you appear the want.
Clearly Cohen acted strategically here by defaulting. But the banks acted strategically as well by relying on a government guarantee that was cheeper then they themselves could provide. Even relying on an implicit guarantee, such as being to big to fail, is strategic if you believe that the guarantor has the ability and willingness to pay.
The above has been covered before and you allude to government being the solution. But the issue is that making these sorts of explicit or implicit guarantees is exactly the strategic choice for politicians. These types of guarantees provide immediate benefits for taxpayers and banks, but any losses are pushed into the future.
The example being discussed here is particularly relevant since the person exhibiting strategic behavior as a homeowner is exactly the same person who is now free to exhibit strategic behavior as a politician.
Everybody gets one vote but a rich person has more money, so who’s interests would a strategic politician be more in tune with?
This is hardly a closed issue either. the obama administration recently expanded the governments role in issuing and guaranteeing student loans. If repayment is capped at 10% of income and the loan will be forgiven in 10-20 years regardless of outstanding balance what incentive is there for someone to assume debt in a reasonable proportion to the earning capacity of their field?
Barney Frank has proposed that the government should insure municipal bonds:
http://online.wsj.com/article/SB123993403283927985.html
If I’m running a muni desk at Goldman and Mr. Frank guarantees these bonds cheaply, how can I justify a large credit team to my manager? Because of the tax favored status of muni’s many are held by local voters so governments had a strong incentive not to default. But if they are insured by the federal government isn’t the strategic thing to default?
Regarding no/low doc loans (Alt-A), Fannie Mae did these types of loans until ’09.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ac.pGKwsRx5k
Additionally, for strategic defaults in a non-recourse state I’d assume that down payment is more relevant then income or assets.