With Big Shitpile rolling on, there's been a lot of discussion about the ethics of defaulting on a home mortgage. Several people have commented on the hypocrisy of denigrating homeowners for doing the same thing that businesses do, without any moral qualms, so I won't say any more about that here. What I do find odd is the inappropriate personalization of who holds housing loans. This is a typical attitude:
Tom Sobelman, whose family of four lives across the street from Ms. Richey, at 3127 Club Rancho Drive, sees mortgages as a moral as well as financial obligation. He's still paying the mortgage on an investment property he owns nearby, despite the fact that the rent is about $1,000 a month short of covering his costs.
Mr. Sobelman, 37, argues that people who choose to default are unfairly benefiting at the expense of taxpayers, who have put trillions of dollars at risk to bail out struggling banks. "All these people are gaming the system, and I'm paying for it," he says. "My kids are going to be paying it off."
Imagine you're renting from a landlord under a yearlong lease, and you decide that you're not going to pay the last three months of the lease; you've decided you're not going to renew, and by the time your landlord can evict you, you'll be gone anyway. If enough renters did this, this would force landlords to raise rents to cover the missing months. This would be unfair to other honest renters, who through no breach of contract on their part, would now have to pay higher rents.
Arguably, if you walked away from a mortgage owed to a local bank, this would have a similar effect: other (future) borrowers would have to pay higher rates to make up the costs of the foreclosures. But this assumes that the primary activity here is providing a place to live, and some potential retirement equity. In light of the importance of having a place to live (and modest retirement equity), 'playing by the rules' matters.
But, over the last decade, housing has been transformed into an investment, which has made 'playing by the rules' inoperative in two ways. First, lenders willingly, if not enthusiastically, provided loans for overpriced housing: nobody went to the bank with a gun and demanded that they receive $500,000 for a housing loan, that, in a sane market, would have been only worth $300,000. It's not as if banks and mortgage lenders had never evaluated property before. If you lock someone into an 'underwater' mortgage (the mortgage costs more than the house is worth), you've given the borrower incentive to walk away--this wasn't a responsible loan.
This wasn't about making a decent profit by enabling people to buy reasonably priced homes. In some markets, prices were increasing by thirty percent a year or more, while wages stagnated. A cautious lender would have pulled back. As Steve Randy Waldmann puts it:
I think that underwater homeowners ought to walk away from their loans for the very same reason McArdle wants us to consider them jerks for doing so. We both want to see norms we consider valuable enforced. I think that banks violated a great many norms of prudence and fair dealing in their practices during the credit bubble, and that they violate the fundamental norm of reciprocity by fully exploiting their own legal rights while insisting that borrowers have a moral obligation not to exercise a contractual option. In order to strengthen norms I consider crucial, I hope transgressors face legal and social consequences (strategic default and reduced shame attached to default) that will alter their behavior going forward... As a practical matter, I think we must rely on creditors rather than potential debtors to differentiate between wise and unwise loans.
The second problem stemming from transforming housing into an investment is that the loan itself became a commodity. Loans were sold to other parties (which caused itself trouble, since lenders had no long term commitment to the solvency of the loan), who in turned bundled those loans and sold them to other parties, who, themselves, often took out derivatives on these loans (and even derivatives on the derivatives). Whatever 'community' responsibility one has to honor debts, so that the lending system doesn't breakdown, simply doesn't exist. Many of the people hurt at this point are financial speculators that are extracting wealth, as opposed to creating it (by providing loans).
To put it more succinctly, it's bad when the ability of your local bank to make housing loans tanks because you choose not to meet your obligations. But why should you feel obligated to honor Bear Stearns' commitments? (Answer: you shouldn't). We honor loans because we all profit by it, but if speculative activity increases the cost of housing (that's what a housing bubble means), who cares if the speculators themselves take a haircut?
To put it more succinctly, it's bad when the ability of your local bank to make housing loans tanks because you choose not to meet your obligations. But why should you feel obligated to honor Bear Stearns' commitments? (Answer: you shouldn't).
What a flaming wad of bullshit!
The obligation is not Bear Stearn's. It's the borrower's. The borrower signed a legal contract to repay the loan. If the lender somehow misrepresented the terms of the loan at the time of the application and closing (which does happen), that's one thing. Such a loan is arguably fraud. However, if the borrower took on more than he could afford or took out a mortgage with little or no equity in the form of a downpayment, hoping (as so many did during the bubble) that the increase in value of his house would give him enough equity to refinance when the rate adjustments started to kick in, then it's just tough if the housing market tanks and the value of the house falls to the point where the loan is under water. That's the chance you take when you take out a loan like that or when you take out any mortgage for a house in which you have little or no equity.
We honor loans because we all profit by it, but if speculative activity increases the cost of housing (that's what a housing bubble means), who cares if the speculators themselves take a haircut?
No, we honor loans because they are legal contracts. Speculators are irrelevant. I don't give a rat's ass whether speculators take a hit from the bursting of the housing bubble any more than you do, but you're just using their behavior as an excuse to justify borrowers breaking their contracts and defaulting on their obligations. Sorry, it doesn't fly.
I donât think I agree with Orac. Sure, we have a moral obligation to keep our promises; but Mike the Mad made the point that walking away from a loan, and thus the house as well, is one of the options in the contract. Iâd be interested in hearing that refuted if it can be.
Also, I note, as Mike alluded to as well, that bosses will happily drive their companies into bankruptcy, taking the money for themselves, and caring not a whit about the promises made to the workers and retirees. Walking away from a home load is almost nothing in comparison.
Yes - it's a contract. It says that I will either repay the loan (mortgage) or give back the house (foreclosure or short sale). So the contract has two options: Pay (1) or lose the collateral (2). When a house is underwater, option 1 makes no sense; option 2 makes sense and is provided for in the contract!
My own house is going to short sale, because the mortgage/finance industry destroyed its value. The mortgage/finance industry is suffering losses that it created - this is not a bad thing; it's how capitalism is supposed to work.
I'm not losing any sleep over this short sale. Anyone else in this position should make the intelligent financial decision *as provided for in the mortgage contract.*
Oh - and for all you "it's not moral whiners" out there, I'm not getting off scott-free. I've lost thousands of dollars in value on the house, and my credit rating will take a hit. This is not even to mention the emotional toll this has taken on me - it's no fun beign threatened by a mortgage company when they try to weasel out of *their* contract obligation.
I also think the moral obligation question is moot for mortgages. They're contracts, and contracts are legal, economic documents, not moral ones. Sure, there may be a social cost if lots of people walk away from loans they could pay (and the actual statistics do not make clear how much of a problem this really is--I think it is more talked about than actually done), but as far as the contract is concerned, it's pretty simple--the terms of the contract spell out what happens if you pay, and what happens if you don't. In various states there are various applicable laws in various situations. The possibility of nonpayment is supposed to have been already accounted for (it wasn't, adequately, by the banks, but that's a tangential problem). If you don't pay an obligation, you are rated a skunk by the credit agencies and no one will give you another loan for at least an hour. I don't feel sorry for the banks at all--they set themselves up for this fall. They removed incentives for a borrower to stay in a house--such as requiring downpayments, and removed incentives for their own selves to be more picky about who they gave a loan.
The only reason this is being cast as a "moral" issue is that huge-ass corporations want to retain the privilege of efficient breach for themselves, while hoodwinking individual borrowers into thinking otherwise. It is bullshit oligarch propaganda.
"Imagine you're renting from a landlord under a yearlong lease, and you decide that you're not going to pay the last three months of the lease; you've decided you're not going to renew, and by the time your landlord can evict you, you'll be gone anyway. If enough renters did this, this would force landlords to raise rents to cover the missing months."
You touched on the bigger issue but failed to follow through. The problem is presented as if it is centered on contracts, trust, and obligation. But IMHO the real issue is one of people assuming that predictions of profit have weight and value in and of themselves. That even if some prediction of profits don't pan out that these failures are regular enough to roll into the estimated worth of the deal and that, by any means, the people 'deserve' to be paid.
The shift has been over the interpretation of speculation. Depression era thought was that you don't bet the butter and eggs money of speculation. Now, speculation is how many people earn the butter and eggs.
In the above example the landlord isn't out much of anything. He/she has first and last months rent and a security deposit and can rent out the house as soon as it is vacated. It happens. People die, or are drawn away by jobs or circumstance and they leave. A few might continue to pay rent to complete the lease agreement but most won't. Most landlords are happy if they don't wreck the place.
Point being that up and down the line the situation was driven by people who were making a killing on based on a piece of paper. Developers built on speculation of a need for the houses. Builders built oversize houses based on predictions of that being what would sell. Flippers sold overbuilt and oversize houses based on predictions of an ever growing market and financed it al with loans full of lies. The loans were resold based on assumptions of reliability and resold again with the blessing of rating agencies who were making a profit on lies and assumptions that the value could only go up. At every step the people were counting money that wasn't in evidence.
Depression era wisdom was you don't count your chicks before the eggs hatch.
Of course if you want to walk around this bush in the direction of enforcing contracts you would do well to start high and work down. Major corporation routinely avoid contractual obligations. Have you ever tried to get a refund? How many union contracts got tossed out when the corporation 'ceased to exist' by selling itself to a subsidiary. Or more commonly, simply selling assets to one group and liabilities to another.
The change over time has not been that contracts have been ignored. A contract is only as good as its enforcement mechanism and value extracted will never exceed the face value minus the cost of enforcement. The real change has been that whereas people with power and wealth have always played by these underhanded rules the middle and lower classes have adopter the practices.
Orac is wholly incorrect. When you sign your mortgage agreement, you are signing a document that states the following in as many long Latinesque words as possible:
"I am borrowing money from this lender to buy a house. So long as I continue to make my monthly payments per this agreement, title to the house rests in me. If I fail to make my monthly payments per this agreement, title to the house reverts to the lender."
If a borrower stops making their payments for whatever reason and walks away, they are not violating their mortgage agreement. They are acknowledging that their cessation of payment means that they no longer own the house, the bank does.
There is nothing immoral or unethical about walking away from this situation. This is a rational action in full compliance with the terms of the mortgage agreement.
Just to state my position up front- I think this is tremendously complicated. I also recall a certain study about whether drivers being 'assholes' (e.g. driving on the shoulder) in traffic jams could actually be an advantage. The answer is- it depends how many people try to pull the stunt (I was surprised to find that an optimal solution existed with around 40% of drivers pulling these maneuvers; we're probably *too* inclined to follow the rules for efficiency for everyone). It seems to me that if you are going to make it a moral issue some people *should* default on purpose and some people *should* work to pay it back; it's highly dependent on the specifics.
What about a student who ends up with hundreds of thousands of dollars in debt from a bachelor's education that will never pay for itself?
Does it matter if the student had evidence to suggest they were making a good investment (i.e. good school, worked hard, majored in something useful)? Does it matter if they have always been gainfully employed; just not at a rate that will pay back the loans?
Or does the fact that on an educational loan a bank is left holding nothing (as opposed to a property of deteriorated but still useful value) trump that?
It seems to me that, for any kind of loan, the very factors that make the *lendee* responsible are those that meant that the bank was making a reasonable decision. Therefore, by the standard of "sending a message to the banks to be more responsible" it is only previously irresponsible lendees that ought to be more irresponsible by defaulting on purpose. All in all, horribly unjust to those that pay their bills and didn't get into mortgages for houses with a bubbled value.
Orac- do you know how badly the market has crashed? Are you sure there aren't people out there in particularly inflated markets (oh, say places where biomedical people like to work, e.g. Boston or San Francisco) where you could have a 30% downpayment and still be underwater? I'll bet you a cookie you could find such a story if you looked hard enough.
This crisis is big enough it's not hard to find people who 'did everything right' who are getting royally screwed.
"My own house is going to short sale, because the mortgage/finance industry destroyed its value."
Now that, I'm afraid I have to question. Things are worth what people will pay for them. Now if somebody *would* pay what you bought for your house, if they could get a mortgage for it, you may have an argument. On the other hand, if there are no buyers at that price, technically, the value of your house was something that basically evaporated (think of the effect of driving a new car off the lot on it's 'value'). Or, arguably, it never existed and you overpaid.
When I bought my house, new houses typically were tiny houses. Realtors advised me that I "might as well buy now, because interest rates will only be going up." I wound up with a 16.5% rate, and rates began to plummet after my purchase. At least at that time, the bank (and other sources) provided advice on how much of one's income could generally be applied to a mortgage. How many first-time buyers in the past few years really understood what they could afford? How many expected to lose income? How many were warned of the danger of unrealistically rising prices? When I refinanced, I did not feel sorry for the bank. After all, they collected a fee to determine if I could afford to pay a few hundred dollars per month less.
Realtors advised me that I "might as well buy now, because interest rates will only be going up."
That should give everybody an indication of how good the financial advice real estate agents provide usually is. I'd definitely rely on one for understanding the ins and outs of getting through a home purchase legally and safely. That's about it, though.
One of the biggest, bailed out banks in the country walked away from a mortgage for several office buildings.
There is no moral obligation to pay a mortgage