If your house is worth 75% or less than what you owe on your mortgage, should you mail the keys to the bank and just walk away?

This question, with its sharp moral edge, has been debated since the beginning of the housing crisis. And today there is some new information, in the form of a survey by First American CoreLogic.

According to CoreLogic, nearly one in ten mortgages is on a property that’s worth less than 75% of the outstanding mortgage principal. That shockingly high proportion will rise if the housing market continues to correct downward, as I believe it should in many parts of the country. The survey also puts a number on what it would take to simply gross up all of those deeply underwater mortgages: $745 billion, about 6% of the total value of American residential mortgages now in force, and about 5% of GDP.

The housing market, like all others, has its cyclical highs and lows. And high unemployment means that many homeowners are having serious trouble paying their mortgages. But this downturn has a unique feature: millions of employed people are staying current on mortgages that they can afford, even though the value of the underlying house has fallen well below what they owe.

In strictly practical terms, this is an irrational thing to do. There’s evidence that perhaps half a million people so far have gone directly into default from being current on their mortgages, without missing any payments. These presumably are the people who are just “walking away” as a matter of economic logic.

Of course they’ll take a hit to their credit ratings. But as long as they’re not job hunting (where poor credit will keep them from being hired), their living standards can take a big step up as they trade their monthly mortgage payment for a rental payment on a much nicer space.

So what’s stopping more people from doing this? The moral dimension. Most people believe that a deal is a deal. If you sign on the dotted line, you have to keep the payments up as long as you are able. And further, you should manage your affairs such that you can continue to be able, perhaps forgoing other purchases or staying in a job you dislike.

It’s very unattractive to argue against such a correct and admirable commitment to personal obligations. But in the case of deeply underwater mortgages, the commitment erodes the financial position of individuals, who in effect are paying for something they’re not getting. This weakens the macro economy over time, as people permanently lose a chunk of their purchasing power.

It also keeps the housing market from correcting to lower levels more in line with economic reality. This continued overvaluation diverts capital away from more productive uses.

I can deal with the moral dimension of the argument by pointing out that there is a lender for every borrower. People who bought at the top of the market, or who cashed out house equity multiple times as bubble values rose, borrowed from bankers who simultaneously bet that the good times would continue. Both parties to the contract are responsible for having made a bad decision, and should have exposure to the downside.

After all, a banker or a business borrower would barely hesitate to walk away from an obligation that no longer made economic sense.

So where do we go from here? There are several pathways, but as it turns out, they all lead roughly to the same place.

What happens if five million Americans decide to stop overpaying their mortgages and mail the keys back to the bank? There would be a sharp decline in housing values. There would be another downward leg to the financial crisis, with a big hit to the capital of banks and other institutions holding large mortgage portfolios.

I think the housing decline would be a healthy thing, as this market is still overvalued. I don’t believe we would see a deflationary spiral, a widespread collapse of debt values, and a descent into a full-fledged Great Depression II. This was the great fear when the bubble first started popping in late 2006.

But since late 2008, the Bernanke Doctrine has showed that the modern Fed has the tools to keep this from happening. Administration officials can say whatever they want, but Too-Big-To-Fail is still reality.

What of the decline in individual purchasing power, the so-called adverse wealth effect, that would come with lower housing values? It would be muted because making mortgage payments on an overvalued house diminishes purchasing power just as badly.

But the net effect of the Great Walkaway would still be a strong downdraft in the overall economy.

What if we just use taxpayer money to give a mulligan to everyone with an underwater mortgage? In other words, the Treasury would write a big check to your bank, to prepay enough of your mortgage to bring the principal amount back down to reality and give you a much lower monthly payment.

Thanks to CoreLogic, we now have a rough guess what this would cost: about $745 billion. We would in effect be borrowing this money (adding to the federal deficit), and applying it as capital to the balance sheets of the lending institutions that currently hold underwater mortgages.

Of course, those lenders would take a large hit to earnings. They’re now in the enviable position of receiving payment streams that are far above current market values, because homeowners think it’s morally wrong not to overpay for housing. Lenders would need to put the new capital out at much lower rates of interest, most likely by buying longer-dated Treasury debt.

Alternatively, they could negotiate to receive more than a dollar from taxpayers for each dollar they apply to mortgage prepayments, to compensate them for the hit to earnings. (Just don’t let word of that get out. Taxpayers would have an apoplectic fit.)

This would probably also trigger a relatively orderly decline in housing values, as people who are no longer underwater suddenly become able to refinance and move into less-expensive houses. The net effect would be similar to the Great Walkaway, perhaps somewhat less disruptive: a sharp decline in economic activity, followed by a fast readjustment to more sustainable growth conditions.

The problem with the Big Mulligan idea is, again, moral. What justifies giving such a large gift to several million people who, it must be said, made bad or even exploitive financial decisions? How can we justify to taxpayers at large that they must pay for the mistakes of others? And how do we justify allowing lenders to walk away from some mythologically bad business decisions without losing so much as a penny?

And at a time of bitter public anger over high deficits, how can we justify adding another 5% of GDP to the public debt? This idea is probably a non-starter.

What if we do nothing? Then we’ll continue the current overvaluation of the housing market, and the erosion of personal finances for years to come. The net effect of this will be a reduction in overall economic dynamism and growth, as capital continues to be misallocated to the overvalued market.

As you see, the Great Walkaway, the Big Mulligan, and the Do Nothing ideas all lead more or less to the same place. As a society, we have sustained a huge decline in asset values as the housing bubble popped. And we’re going to spread out the impact of the decline and suffer it in a socialized way. Several more years of economic weakness are ahead, no matter what happens here.

The most likely outcome is halfway between the Great Walkaway, and Do Nothing. Many more people, perhaps millions more, will mail the keys back to the bank. What can be done for them?

I expect that Congress will come under pressure to declare a “credit-rating amnesty” for people who default on deeply underwater mortgages. The rating agencies will either be required to suppress such defaults after a much shorter amount of time. Or users of credit records will be required to discount or underweight them when making credit and employment decisions.