Ruthless Default

Now let us praise Ruthless Defaults.

In the lexicon of financial institutions that extend consumer credit, a 'ruthless default' is a decision of a consumer borrower to discontinue servicing his or her debt obligations even though current cash flow (or unused borrowing capacity) would allow that borrower to do so. Rather than being recognized as a prudent financial decision in some circumstances, it is subject to mockery and denigration on a blanket basis. The mockery tends to focus on the past bad financial decisions the borrower made to get into the current financial bind (such as overpaying for a house or incurring uninsured medical expenses). The denigration tends to focus on the sanctity of contract, which is an escalation in to the moral sphere of earlier warnings about damaging one's credit rating.

Leaving the mockery and denigration aside, as I understand the concept, a ruthless default occurs when a person assesses their current financial situation and makes a 'zero based' decision on how to go forward. The priority given to staying current on the mortgage, the credit card debt and car payment, versus buying groceries, continuing the 401(k) contribution and keeping the utilities turned on, is matter of personal decision. The borrower disregards how he or she came to be in the present situation, and prioritizes and makes decisions on the basis of what makes the most sense going forward.

To the chagrin of commercial lenders, consumers stupid enough to have succumb to all sorts of insane credit blandishments in a prior incarnation, are turning out to be intelligent enough to realize that it's more important to keep the lights turned on than to protect the vanished equity in a house that they will eventually lose to a short sale or a foreclosure. And retirement plan balances frequently have greater protection in a personal bankruptcy than the personal goods bought on credit.

So, call it ruthless, call it self-interested, default is apparently beginning to occur with sufficient frequency that it's gotten the attention of industry and of the main stream media. It's not clear whether it will become so widespread as to impact general public attitudes towards indebtedness, but is becoming clear that earlier industry and rating agncy assumptions about the behavior of consumers in financial distress are no longer operative.

There should be no surprise in this. People are going to put protecting themselves before protecting the people who have lent them money. What is a little surprising is the reasonable conclusions people are reaching about how best to protect themselves. At a minimum, people have lost faith in the proposition that house prices only go up, and that your house is the best investment you'll ever make. Beyond that, I'm getting the sense that the weird belief that a good credit rating, or credit score, was some kind of financial 'asset' is beginning to fray, though I'm not ready to announce a return to a 'pay as you go' mentality.

One interesting thing about ruthless default is that it is an alternative to entering the chute of credit counselling, debt repayment plans or personal bankruptcy. In each of those officially sanctioned alternatives, the debtor relinquishes autonomy over his or her personal finances in exchange for some form of forbearance and accomodation. By contrast, ruthless default is a zen move. The debtor simply does nothing (more precisely, stops making paymens) and leaves the response up to the creditor.

The mortgage servicer can initiate foreclosure, foreclose and pursue any deficiency. The credit cards can be cancelled. The car can be repossessed. Foreclosure takes months. The cancelled credit card issuer is still stuck as a general unsecured debtor for a bad loan. Only the repo man gets his collateral back promptly and in immediately saleable condition. But in everyone of these situations, the transaction costs and the administrative effort associated with pursing the remedy was simply not factored into the original extension of credit. And the machinery to accomplish the remedy is not in place, at least systemically at the levels of activity required to respond to widespread ruthless default.

Or perhaps I should say 'rational default'?