If you want a clear as day example of “moral hazard”[1] and the perverse incentives bailouts can have on people read an article in today’s Wall Street Journal titled “American Dream 2: Default, Then Rent.” [2]
Basically you have a group of people in Palmdale, California who, enabled by lax lending on an unprecedented scale during the real estate bubble, borrowed well beyond their means to buy houses now worth much less than the mortgages on them.
So what are some of these folks doing?
Defaulting on the mortgage, allowing the home to go into foreclosure, and then renting bigger houses at cheaper rates in the same area.
They are somewhat protected since California is one of ten states where lenders are, according to the article, by law restricted in their ability to go after the borrower’s other assets to cover any money not recouped by the sale of the foreclosed home.
A troublesome situation already but something anyone who’s ever gotten in over their head can understand at some level.
Here’s the kicker: since the cost of renting is much cheaper than the cost of ownership (for a variety of reasons; see the article) and the bank cannot come after the borrower’s other assets the folks in the article now have more discretionary income.
What are they doing with this extra cash?
Saving for retirement? Paying off other debt? Building a rainy day fund? Trying to make good on some part of the debt they defaulted on?
No!
They’re getting season tickets to Disney Land, going out to eat more, heading off to concerts, buying expensive furniture, going on cruises to Mexico, and driving BMWs (I’m not making this up).
And apparently they feel no remorse or shame about their behavior as they’ve agreed to admit all of this to The Wall Street Journal.
What happens when a borrower defaults and walks away, the bank sells the house and recoups $195,000 of a $430,000 loan, and the process stops there?
You got it: at some point the United States taxpayer is going to be asked to step in and pick up the tab for the difference (either directly by just giving money to the banks or indirectly by holding interest rates so low that banks can borrow for free practically while everyone gets 1.5% on their savings accounts).
Remember just a couple of years ago when you used to get 5% on a basic on-line savings account?
That 3.5% difference is being used to make irresponsible borrowers and lenders whole.
The result?
Lenders show profits and pay themselves bonuses.
Borrowers reduce their debt loads and spend elsewhere.
Everyone else picks up the tab.
What a scam.
