Question

1. What is strategic default, and how is it related to limited liability and the cost of foreclosure?

Answer 1

Strategic default is preplanned default of borrower to not repay the loans even if he is having the financial ability to repay those loans but he choose not to repay those loans because he will be aware of the consequences, and he will feel that the the cost of paying the loan is higher than cost of not paying the loan. Hence he will choose to default on his loans.

This is related to limited liability because he'll be aware about the limited liability which will be arising out of not payment of the loans so he will be trying to default on his loans and make a strategic default in order to have a limited liability.

Cost of foreclosure will mean that the lender will be trying to recover the loan out of the collateral and buyer has already assessed the cost of foreclosure in advance and he will be willing to make a strategic default.