Posted by Jonathan J. Miller -Thursday, October 28, 2010, 1:53 PM
We all understand that when one has “skin in the game”, they are incentivized to minimize or control exposure or risk. Stories of no money down borrowers walking away from homes as strategic defaulters are common fodder in today’s news cycle.
However, in Spain, mortgage defaulters remain on the hook for their obligations yet that didn’t prevent them from getting swept up in the euphoria of the credit boom in In Spain, Homes Are Taken but Debt Stays [NYT]
So the argument that homeowners without “skin in the game” were morally bankrupt is a one dimensional viewpoint since Spain had the same shoddy lending practices we did. In other words, the fact that people would have to pay the loans back didn’t dampen the credit frenzy of the times. Moral hazard, the idea that someone will help you if you get into trouble without significant penalty, is the default explanation for a lot of the credit mess.
In the US, lenders AND borrowers AND TAXPAYERS are paying for the error of their ways but in Spain, the borrower seems to have much more of the burden. In theory that makes perfect sense – they borrowed money and can’t pay it back. However the big question is whether or not deceptive or predatory lending practices were commonplace in Spain during the boom like in the US.
The point in my ramblings dialog here is that even with an embedded payback requirement in the mindset of the spanish borrowers, they still took risks that they didn’t comprehend. This therefore suggests a larger structure economic phenomenon that drove so many people to make poor credit decisions.
Moral hazard isn’t the easy explanation many seem to think it is.