The ethics of strategic default
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Here are three words that can stir moral outrage: Just walk away.
The phrase refers to strategic defaulters – homeowners who are opting not to keep paying mortgages that they can afford. Unlike the millions of hardship foreclosures afflicting residential real estate, strategic defaulters conclude that it no longer makes economic sense to do so when mortgage balances far exceed the value of a property’s plunging value.
The number of strategic defaults is rising in a chronically ill housing market, and the phenomenon sparks a strong emotional response.
“I would like to know where all the accountability went, and why the government is not holding people accountable for their debt,” wrote one outraged commenter on my post last week about strategic default. “People should also be thrown in jail for walking away from a home while the rest of us law-abiding citizens follow the rules.”
Eighty percent of Americans think that defaulting on a mortgage is immoral if you can afford to pay it, according to researchers at the University of Chicago and Northwestern University. It’s also been argued that homeowners have an obligation to keep paying – if they can – to help preserve neighborhood property values and thereby support the broader economy.
It doesn’t seem likely that Americans would really make big real estate decisions based on what’s good for the community – that sounds downright socialist. But does strategic default constitute a moral or ethical breach?
I posed the question to Robert Davis, executive vice president of the American Bankers Association. He argued that banks want to help homeowners find alternatives to default, and stressed the importance of talking to lenders first, citing the all-but-certain hit to credit ratings, and the possibility that a bank will come after a defaulting borrower’s other assets.
But he stopped short of calling a mortgage a moral obligation. “It’s a strategic decision to back out of an obligation, but the world has changed. Would they like someone else to take on the paper loss that they have? Do people do things like that? Obviously they do.”
Brent White, a law professor at the University of Arizona, has stirred the pot with several provocative articles suggesting that strategic default can be a rational economic move – and that morality and ethics have nothing to do with it.
Instead, White argues that a mortgage is simply a contract – one that spells out the consequences of failure to pay. “In other words, the lender has contemplated in advance that the mortgagor might be unable or unwilling to continue payments at some point and has decided in advance what fair compensation to the lender would be,” he writes.
In an interview, White adds that many underwater homeowners are blameless because they were taken in by hype about homeownership and real estate investment. “They were told by government and the media to buy homes, and that the good, responsible thing to do was to buy, not rent. As late as 2007, the secretary of HUD was saying that buying a home was the best investment you could make.”
But White emphasized that he’s not urging all underwater homeowners to simply walk away. “It’s not a attractive option because there are real costs.” Along with a plunging credit score, there are moving costs and the need to find a new place to live, he notes. Moreover, Fannie Mae recently said it would penalize strategic defaulters by locking them out of Fannie-backed mortgages for seven years, and go after them in court.
However, White notes that the wisdom of a strategic default depends heavily on where you live. Some states have non-recourse laws that prevent banks from going after the personal assets of homeowners who default; others don’t offer consumers this protection.
“People have to weigh their circumstances and make a decision,” he says. “In my view, there’s no moral difference between an individual defaulting on a mortgage and a corporation doing the same thing.” (See: Tishman Speyer and Morgan Stanley).
The propensity to walk away from a mortgage rises among homeowners whose negative equity exceeds 10 percent of home value, research shows. But White counters that the definitions of ability to pay can be murky, and that the decision to walk away can be more emotional than rational.
Says White: “People who do strategic defaults are at the end of their emotional rope. They don’t default just because it’s a rational decision, but because of anxiety about the future. They try to contact their lenders and can’t get help, and they start to feel hopeless – and angry. The banks have been bailed out. Homeowners who they consider irresponsible have been bailed out… (But) if you keep paying, you’ll get no help. So they are pushed to default by a sense of injustice and anger.”
Photo: Foreclosed house for sale in Denver, Colo., in March 2009. REUTERS/Rick Wilking
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The Mortgage Bankers Association did a short sale on their former national headquarters in Washington, DC.
They walked away from 40 million dollars of debt. How dare they point their crooked, bony fingers at people who are faced with losing all or most of the value of their homes. A lot of ordinary people were relying on the gains realized from the sale of their home to sustain them in their retirement years.
The mortgage companies gambled and lost big. Then they were made whole by the taxpayers. Who is going to make the taxpayers whole?
1/3 of all home foreclosures are strategic
Morals? Since when did banks or other financial institutions care about morals? Or integrity? Or ethics? Financial institutions care (and have ALWAYS cared) about one thing MAKING MONEY! Stupid people engaging themselves with financial burdens they knew they could never honor is nothing new. What makes this problem new is that people have forgotten the last time it happened.
The problems we face now are due primarily to Free Trade Agreements. ARMs only work if you make more money when the rate adjustments kick in than when you started. Normally people get hired, move up the ladder, and retire. Now companies regularly pull up stakes, ship their production facilities out of this country, and move them to places that have no ecological impact standards, and lower employee safety standards. This makes production cheaper. If we were to go back to charging countries and companies tariffs to import items, the savings made in production would be off-set by import taxes, and the manufacturing base would come back to this country. Until we end our free trade agreements and start producing things here again, we are going to continue to see the manufacturing base erode, the economy will continue to collapse, and people will continue to let their mortgages default.
-Oz
One point that hasn’t been commented on:
The threat by Fannie not to give mortgages to strategic defaulters is totally empty.
Think about the practical application of this policy. It will be impossible to implement – impossible to determine hardship from strategic defaults.
Is there a survey that people fill out when they default that asks “Did you default due to hardship or are you making a strategic default?”
Okay, this is a joke–right? Seriously, these ‘bankers’ are the same ‘financial experts’ whose unethical behavior and amoral greed have financially sunk this country. Yet while legions of people struggle, they still glom their bonuses like spoiled schoolyard bullies. An average crack whore’s pimp would look morally beyond reproach when compared with one of these evil maggots.
@puzzled. Your comment is spot on!!!
Just as corporations are considered Persons and act in the Financial Interest of their Stakeholders, home owners have a Financial Obligation to Protect: a) their Own Corporation of (your Family Name here), and b) their Stakeholders (Family Members) to increase Profits. What is good for the goose is good for the gander. Don’t be naively shocked when people claim the same rights as they do. Morals and ethics are non sequitur as exemplified by Wall Street and the Financial Sector’s unacceptable behavior and performance as of late. If underwater Main Street homeowners don’t receive their Bail Out as Wall Street Criminals did when they Privatized their Profits but Socialized their Debt (aka stealing), then homeowners feel Zero Guilt, and actually feel satisfaction in, Bailing themselves out by abandoning a mortgages. Stop complaining and swallow your medicine – we did.
Let’s Talk Morals:
With all the trillions of taxpayers money dished out by the government, why didn’t they simply pay off the mortgages and enable debt-free homeowners to become commodity and appliance purchasers, thus strengthening the economy? The answer is simple: All parties opted to bail out the stinking rich and penalise Joe Blow. This chicken is coming home to roost. People are very well aware that each of these foreclosed homes has been stolen from a man-in-the-street and all those ‘homeless’ will become the tide that ‘resumes’ dwellings without bothering with mortgages OR money. You want them out – decide which end of the street you will start at and bring guns! That’s the answer to Wall Street Morality.
@puzzled. Your comment is spot on!!!
There is a huge difference with regard to the behavior that one tolerates from a corporation and from an individual. We only have to look at the legal system to realize that. The issue is that when an individual takes out a mortgage they are entering into a valid agreement where they promise to repay. That argues for not encountering a strategic default. However, and this is where people seem to get hung up, the mortgage and contract law also provides for remedies if you do not pay. So upon signing the contract you are acknowledging both.
The costs of a default are loss of property, possiblly being on the hook for the difference, and a disastrous credit history. You may in the future be unable to obtain credit, possibly even rent and appear in a Free Credit Report.com ad/
One issue that we are grappling with is does society make the strategic defaault an acceptable action where you become a folk hero or do they look at you as someone who walked away from an obligation that maybe you could have honored.
If our childrens’ generation needs to be answering the question I think that without a doubt the answer should be that a strategic default is acceptable becasue the business world either hasnt learned or learned enough to conclude that the profits made in the good years are better than the losses in the bad.
As much as I dislike them I think that at times they do make sense and that they are simply being done in fulfillment of a contract, but it is also a practice I would not want to teach my kids.
I walked away. I wrestled with the thoughts of being a bas man and such, then I saw Trump casually go into bankruptcy one day and I was over it. The only thing I feel now is stupidty for being so gullible and believing that a house was an investment. There are no Stepford Communities. Your home as an investment is fleeting at best. Your neighborhood could be ruined by the next toxic spill, or crooked derivative trading Phil Grahmn type of politician. Save yourself. Banks won’t. Government won’t. Walk away.
My home is underwater by around 12% and I’m staying. The consensus seems to be that I am foolish and wasting money, but I gave my word when I signed that contract. I feel that in these times of uncertainty and hardship a person’s word becomes ever more important in dealings with others, even when those others are seemingly amoral companies and governments. I’m not a hardcore conservative or liberal, and I’m certainly no idealist but for today and the forseeable future I’m keeping my promises.
Jesus, I feel like a maudlin PSA narrator. But seriously, this country seems to be going sideways at a high rate of speed and I feel like individuals that don’t keep their word have no room to complain about others who don’t. I work in quality assurance and ignorance is no excuse if you’ve signed for something that can get people killed.