It’s called jingle mail—when a homeowner seals the keys to his or her house in an envelope and leaves them with the bank that holds the mortgage on the house. (A mortgage is a loan taken out to buy a house.) By leaving the keys with the bank, the homeowner is walking away not only from the house but also from the obligation to continue paying the mortgage. And to their great consternation, banks have been flooded with jingle mail.

To default on a mortgage—that is, to walk away from one’s obligation to repay the loan and lose the house to the bank in the process—used to be a fairly rare phenomenon. For decades, continually rising home values made homeownership a good investment for the typical household. In recent years, though, an entirely different phenomenon—called “strategic default”—has appeared. In a strategic default, a homeowner who is financially capable of paying the mortgage instead chooses not to, voluntarily walking away. Strategic defaults account for a significant proportion of jingle mail; in September 2010, they accounted for 36% of all foreclosures, up from 26 percent in 2009. And there is little indication that number will change dramatically: through 2013, 20% of all mortgages remained underwater with another 20% of homeowners barely above water.

What happened? After decades of huge increases, house prices began a precipitous fall in 2008, known as the Great American Housing Bust. Prices dropped so much that a significant proportion of homeowners found their homes “underwater”—they owed more on their homes than the homes were worth. And with house prices projected to stay depressed for several years, possibly a decade, there appeared to be little chance that an underwater house would recover its value enough in the foreseeable future to move “abovewater.”

Many homeowners suffered a major loss. They lost their down payment, money spent on repairs and renovation, moving expenses, and so on. And because they were paying a mortgage that was greater than the house was now worth, they found they could rent a comparable dwelling for less than their monthly mortgage payments. In the words of a Florida resident, who paid $215,000 for an apartment in Miami where similar units were now selling for $90,000, “There is no financial sense in staying.”

Realizing their losses were sunk costs, underwater homeowners walked away. Perhaps they hadn’t made the best economic decision when purchasing their houses, but in leaving them showed impeccable economic logic.

9-4

Solutions appear at back of book.

In early 2013, the department store chain J. C. Penney unceremoniously dumped its recently hired chief executive, Ron Johnson. The action followed a disastrous 2012 for the company, in which sales dropped 25% to $13 billion. And it was a humbling defeat for Mr. Johnson’s strategy of “everyday” low prices, implemented in early 2012.

A year before the one-price strategy was put into effect, the company held numerous sales, 590 of them in fact, and almost three-quarters of its goods were marked down 50% or more. Yet customers weren’t actually paying less. The chain would just raise the prices of merchandise on the racks and then discount prices during the promotions. But why play an expensive game that is costly for the company and an illusion for customers?

So the new strategy seemed like a no-brainer for J. C. Penney. Rather than continue to promote sales and offer coupons, customers were now assured a low price at all times, regardless of the season and without clipping coupons.

The company reaped benefits from the strategy in the form of cost-savings from more accurate inventory and profit projections, from more consistent revenues, and by eliminating the need for manual labor to continually change prices. As John T. Gourville, a marketing professor at Harvard Business School, noted, a one-price pricing strategy “makes the operations side of things much easier. You don’t have the whiplash effects of selling, say, a ton of Diet Coke one week and virtually none the next week.”

But, there were problems with this pricing strategy as well. Just how low the prices were wasn’t clear. “Trust us,” was the message J. C. Penney communicated to its shoppers, “We will give you a fair deal.” In addition, unlike Walmart, Penney did not offer to match competitors’ prices, and it could not depend on making up for tiny per-item profits with a high volume of regular customers. Unlike Costco, it would not make money from annual membership fees. And a one-price strategy doesn’t draw customers in during seasonal high-intensity shopping times, like Black Friday, when the holiday shopping season officially starts.

Mr. Johnson’s strategy clearly alienated Tracie Fobes, who runs Penny Pinchin’ Mom, a blog about couponing strategies, who said, “… seeing that something is marked down 20% off, then being able to hand over the coupon to save, it just entices me.”

So with Johnson’s departure, J. C. Penney backtracked and began offering coupons and weekly sales again. And the store assistants went back to work, marking items up in order to then immediately mark them down.

QUESTIONS FOR THOUGHT