In some cases, it may be a sound economic decision for regular homeowners, not the subprimes or ARMs, but just regular homeowners, to mail in their keys and walk away from their house.
If you have a $500,000 mortgage, and your house is now worth $300,000.. The fiscally responsible move on the part of the homeowner should be to walk away. Mail the keys to the mortgage company, and immediately stop paying the mortgage. Let the bank foreclose on it.
Businesses do it all the time, go, "well, that didn't work out, let's close the plant and fire all the workers and try something else." and end up just walking away from their mistakes. There's a short-term cost to be paid, sure.. Businesses pay for worker retraining and severance pay, homeowners get 7 years of bad credit.
BUT... You're no longer pointlessly hemorrhaging money.
Which leads us to the danger:
If, as in the previous example, you have a $500,000 mortgage, and the house next door, identical to yours in every way, is for sale for $300,000.. Do you save yourself $200,000 dollars? Some people are realizing that they can buy the house next door or down the block or whatever and then walk away from the first, $500,000-mortgage, house. You even get a great interest rate because you have good credit prior to putting the first house into foreclosure.
$200k pays for a lot of barhopping/kids/cars/boats/whatever that you could spend on yourself instead of just giving it to the bank.
This is already starting to happen.
1 - People walk away from their underwater mortgages --> more foreclosures --> more homes on the market --> lower prices to get them to sell --> home prices in that area dropping --> more people underwater on their mortgages --> more people walking away from their homes.
2 - GOTO 1.
What do you suppose happens if, say, even 1/64th of all mortgages in America goes into foreclosure?
The Fed is trying to prevent this by lowering interest rates and basically giving banks free money in the hopes that lower interest rates will cause people to start buying houses again. I'm not entirely sure that'll happen. People's living margins are razor-thin nowadays, lots of personal debt, income isn't growing, living almost paycheck-to-paycheck. Will people decide "Okay, that's as far as the housing prices are going to fall, if I buy now I'll get some bargains."?
That's the question everyone is wondering.