CBS had a segment on 60 minutes called “House of Cards: The Mortgage Mess.” They had an interview with a couple that had a fixed-rate loan, a prime borrower and had an ability to make payments on their home, instead they are going to foreclose. Their economic logic is simple, they weighed the penalties versus the benefits, and because they owe more money on their home than what it is worth, they are going to walk away.
This effectively deepens the hole, giving other borrowers with the ability to make payments greater incentives to foreclose. In the face of so much bad debt, creditors will be forced to raise interest rates. In the end, there might be plenty of cheap houses on the market, but people will be unable to get credit to buy them.
The underlying point is that a society needs a component of trust instead of exclusively relying on economic self-interest. A trust, a social contract, that has been under attack long before this particular crisis developed. It is the trust that people will not just take into consideration their own interests, but also the burdens they are placing on society by their actions. In an era of globalization, flexible labor markets, rampant consumerism and borrowed prosperity, maybe it should come as no surprise that this sensibility has become more an exception than the rule. However, we should not delude ourselves about the nature of the collective failure, and the need to reform it. In the immortal words of Franklin Delano Roosevelt: “We have always known that heedless self-interest was bad morals; we know now that it is bad economics.”