So, welching on a mortgage debt, fair or foul? Contract law has always treated contractual promises as outside the scope of morality (with certain equity exceptions for duress, unconscionability, etc.). Assuming two capable adults, a contract gives each a choice: perform or pay damages – no moral culpability attaches either way.
So if you buy a house for a $1 million and a bank loans you $800,000 to help buy it, both parties are assuming certain risks. one of which is that the property value is sufficient to justify the price you’re paying and to secure the loan in the event of your default. In states that don’t allow lenders to pursue recourse beyond the property (and Shoeless, I believe Connecticut does), that bank is knowingly assuming the risk that the property value will drop. If it does and the borrower walks, he has still performed his side of the contract: he didn’t perform by paying back what he borrowed but the agreed -upon-in-advance damages are the house. If he hands over the keys, I’d say he had done all that he was obligated to do. In states that do allow recourse from other assets the defaulting borrower’s life is made more miserable but still, I don’t see the immorality of his actions.
Sit down at a restaurant and you are entering into an implied contract: if the restaurateur provides a meal, you will pay for it. If, upon presentation of the check, you discover that you’ve lost your wallet, you have not broken any moral law, but you are obligated to return to pay for the meal you consumed or, if this is the movies, wash dishes. Sneak out the back window and that’s a crime. Come in originally with the intention of dining and then sneaking out the back window, that’s a bigger crime.
I’m sure I’m not the ony one raised to believe that an honest man kept his word and paid his debts. But that’s a private morality and not something recognized by law.
Conditions set out in a contract are all that bind the two parties. As another poster said earlier, my concept of morality and “walking away” have become more distinct instances after the TBTF banks got handouts to shield them from their stupid decisions and we got the bill. ‘Eff ‘em.
Interestingly, there is much in the way of common ground at the moment between the populist Left and the free-market Right. While each have their own reasons for detesting the route politicians have chosen to navigate this crisis, the overlap is almost unprecedented. Strange bedfellows, indeed.
I agree that morality doesn’t come into it. The parties are aware ahead of time whether they are in a no-recourse state, so presumably mortgages are priced accordingly and the downpayment requirements take this into account as well. If not, shame on the lender. I see nothing wrong with walking away if that is a legal option that everybody agreed to at the outset.
From Calculated Risk:
Does Morgan Stanley “Walking Away” from CRE Contribute to Strategic Defaults?
by CalculatedRisk on 12/17/2009 10:59:00 AM
From Bloomberg: Morgan Stanley to Give Up 5 San Francisco Towers Bought at Peak (ht MikeinLongIsland, Brian)
Morgan Stanley … plans to relinquish five San Francisco office buildings to its lender two years after purchasing them from Blackstone Group LP near the top of the market.
“This isn’t a default or foreclosure situation,” [Alyson Barnes, a Morgan Stanley spokeswoman] said. “We are going to give them the properties to get out of the loan obligation.”
…
The Morgan Stanley buildings may have lost as much as 50 percent since the purchase …
Note that Morgan Stanley is current on the loan and is not in foreclosure. They are simply “walking away” because the buildings are worth less than the amount owed.
On residential, the WSJ has an article: Debtor’s Dilemma: Pay the Mortgage or Walk Away? (ht Sabine). The article contains a graph of “strategic defaults” by state
http://online.wsj.com/article/SB126100260600594531.html#project%3DSTRATEGIC_DEFAULTS_0912%26articleTabs%3Dinteractive
- however I’m not sure how this is estimated. In very few cases does the borrower admit they can afford the payments and are just walking away (like Morgan Stanley above). In most cases the borrower either doesn’t respond or says they are having a financial crisis.
From a research paper earlier this year on homeowners with negative equity walking away: Moral and Social Constraints to Strategic Default on Mortgages by Guiso, Sapienza and Zingales.
It is difficult to study the strategic default decision, because it is de facto an unobservable event. While we do observe defaults, we cannot observe whether a default is strategic. Strategic defaulters have all the incentives to disguise themselves as people who cannot afford to pay and so they will appear as non strategic defaulters in all the data.
The researchers argued that the pace of strategic defaults is increasing – and that is terrifying for lenders.
This is what I wrote in 2007:
One of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes.
And that remains the greatest fear – and it probably doesn’t help that companies like Morgan Stanley are walking away from commercial buildings. As the researchers noted, the more people hear about strategic defaults, the more willing they are to walk away. Zingales was quoted in the WSJ earlier this year:
“Our research showed there is a multiplication effect, where the social pressure not to default is weakened when homeowners live in areas of high frequency of foreclosures or know others who defaulted strategically”
I wonder if hearing about “rich” banks that are paying “large” bonuses walking away from commercial buildings also weakens the social pressure?
You’ve certainly beat this drum, CF, but as much as the vast majority of your colleagues try to smokescreen the issue (see lipstick/pig, etc., infra), there is only one knob to turn, and it is price. A market backlog will only be resolved by a market clearing price.
Good post, shoeless.
Let’s not forget all the President’s tax cheats and the example they’ve set, too.
Perhaps the only weapon “the people” have against the rotten system is default. For those of us who wouldn’t mind seeing “the system” go down, and replaced with something better, default IS the moral thing to do. And not just on mortgages, but credit cards, etc. It might even serve to limit our overseas “obligations”. Was just reading about Madame Secretary pledging 100 Billion smackers to other nations to mitigate “global warming”.
Eff ‘em is right. This game is over. Sweep the board and re-set.
Chris, can you clarify? Does Connecticut law allow the bank to pursue recourse beyond the property itself?
Well Shoeless sent link that seems to confirm that nothing’s changed since I did this sort of law. Connecticut is a “strict foreclosure” state meaning that, if there is equity in a house (a dubious likelihood these days), the hose will be sold at auction and after all creditors are paid the surplus, if any, given to the borrower. More important for our purposes is when there is no equity. In that case title to the land, already given to the lender when a mortgage is given (Connecticut is not a “lien” state) is perfected and the borrower’s “right of redemption” eliminated. Te bank then owns the property free and clear of all encumbrances and is free to sell it for what it can get and then go to court and obtain a “deficiency judgement” – the difference between what is owed the bank , including late fees, penalties, attorney’s fees, whathaveyou and the sales price. That judgment can then be turned over to a collection agency and pursued. Not good. That’s why short sales – a pre-agreed loss to the bank – are better, in this state. I think.
Not only would I say that a borrower is within his legal rights to walk away, I would say that in a strict foreclosure state such as CT the borrower is within his rights to stiff arm the collection of the deficiency judgment using any reasonable means including foot-dragging or countersuits.
However, jingle-mailers should forever renounce their right to bellyache about banks or greedy corporate interests.