Not Your Father's Bankruptcy

What's So Bad About Bad Credit??

For many consumers, preserving one's credit rating is one of those sacrosanct, preserve-at-all-costs values.

But what if you don't plan to buy anything? Or are afraid to? Or simply can't afford to?

Then, a trashed credit rating really may not matter so much. Especially if it means ditching a whopper monthly mortgage payment on a house that has plunged in value.

In the new economic landscape that many Americans already inhabit, maintaining a high credit score is a luxury they literally can't afford. In fact, torpedoing one's credit by defaulting on a "legacy" mortgage may be quite rational, for five reasons:

One. Credit scores don't matter if there's no credit to be had.

When credit is flowing, good credit scores can open the vault doors. Now, however, those vault doors are slammed shut even for many good credit risks -- and there's nothing behind, them anyways. (At least not until Uncle Sam replenishes the banks' coffers.)

The "Pay-As-You-Go Economy"

At some point, even the profligate U.S. government is likely to find its own access to unlimited credit curtailed.

In his current letter to Berkshire Hathaway shareholders, Warren Buffett pronounces U.S. government debt the next big bubble, following in the wake of the Internet and housing bubbles.

Once that bubble pops, the government will discover what many consumers already know first-hand: it's increasingly a "pay-as-you-go" world.

Two. No one's buying anything. At least not big ticket items, anyways. And if you're not buying a big-ticket item . . . you don't need credit to finance it.

In many U.S. housing markets now, prospective Buyers have a adopted a "show me" attitude, triggering a vicious cycle: wary of being stung by falling values, Buyers are waiting for the market to clearly bottom, but while Buyers stay on the sidelines, housing prices inevitably fall more.

In the mean time, with more people renting instead of owning, fewer consumers need a good credit score to qualify for a mortgage.

Three. In the land of the bankrupt, the marginally solvent are . . . welcome.

Look around -- it's a recession. People's balance sheets have been hollowed out by falling home and stock prices, and now are being kneecapped by rising unemployment. Exactly who has pristine credit these days?

Beggars can't be choosers, and that's exactly what many retail companies catering to consumers are right now. If it's a choice between selling to marginal customers or not selling at all, many companies will choose the latter.

Four. Perversely, defaulting can increase borrowers' leverage.

Lenders receiving federal bailouts are under increasing pressure to "modify" (read, relax) mortgage terms for distressed borrowers.

How does a borrower signal financial distress? By not making their mortgage payments. Ironically, someone who's current on their mortgage is unlikely to get their lender's attention.

Five. Bad credit can be rehabilitated.

Credit scores aren't static, like college transcripts, but dynamic, like one's health. As consumers handle more credit more responsibly, their credit scores increase; if they miss payments or have multiple delinquencies, they decline.

Over time, most people's credit scores recover from a major default -- just like they recover from a major illness.

Given the epidemic number of foreclosures today, the federal government might logically take steps to shorten that recovery period.