Doomsday Scenarios: Could Americans Stop Paying Their Bills?

What if Americans in large numbers simply stop paying their mortgages and credit card bills? Most people will dismiss this prospect because it is both unlikely and has never happened before. But is it possible? I would argue that every day it becomes more possible if not likely.

Two years ago experts dismissed the prospect of homeowners walking away from their mortgages when they could still afford to service them. But this phenomenon has manifested itself and is growing rapidly. It makes basic economic sense to default on an underwater mortgage at some point, and many borrowers are choosing that very option. As house prices continue to fall, this trend will only increase.

As if this weren’t enough of a problem, each day politicians and policy makers come up with new and exciting ways to reward people who don’t pay their mortgages. You can’t listen to the radio, turn on the TV or perform an internet search without encountering advertisements for services that will reduce your mortgage debt or eliminate credit card balances.

The point is we are creating an environment where defaulting on your debt is no big deal. The Government is actually incentivizing you to default, while reducing the cultural stigma of doing so. People who pay their bills are expected to continue paying them, while also bearing the costs of those who default. But those who default are rewarded with a reduced debt burden, lower interest rates and favorably restructured loan terms.

Sure, not servicing your debt supposedly reduces your credit score, but this is small potatoes relative to the real, immediate and quantifiable financial gain captured by default or restructuring. Furthermore, bad credit has not been an impediment to borrowing for the past decade. (See the Housing Bubble, subprime debt, NINJA loans, the credit card industry) With as many people defaulting on debts as we see today, there is no chance these people will be ignored, ostracized or denied access to credit in the future. The political class won’t allow it and defaulters will represent too large a portion of the market for lenders to ignore.

And from an economic perspective, it is increasingly advantageous to default on credit card debt while prices are deflating. If you thought 16% credit card interest rates were difficult to service during the boom times with inflation running at 3%, try servicing 19% credit card interest rates while prices are deflating and unemployment is rising.

Why would the majority of people continue to pay their mortgages and credit card bills in this political, cultural and deflationary environment?

Throw in the peculiarity of our non-recourse borrowing system and you at least create the possibility of such a scenario. In the United States if you don’t pay your mortgage or credit card bill nothing really bad happens to you. It isn’t a criminal act for which you are punished. Your other assets aren’t confiscated. The lenders only recourse is to harass you for a while before they write off the balance and then disparage your credit.

The Government has effectively incentivized homeowners to default on their mortgages, and anyone who finds themselves in a situation where this possibility is financially beneficial will take advantage of the opportunity. Those people who retain equity in their houses will continue to service mortgages, as long as they have the ability to do so.

But credit cards are different. No one has equity in their credit card. There is, in fact, an immediate and material benefit to not paying your monthly bill. This observation may not have been apparent, or represent a good option during good times, but during a Depression what happens when millions of Americans reach this conclusion? I believe that we will see a massive increase in the number of people who will shamelessly choose to stop paying their credit card bills. And when they do so, politicians will line up in an attempt to reward them.