The Ethics of Mortgage Defaults

Matt Yglesias makes the case for guilt-free mortgage defaults:

My mortgage is an agreement I’ve made with Bank of America which is a publicly traded for-profit corporation. Companies like that, unlike people or people agencies or other kinds of institutions, don’t recognize any kind of goals other than monetary ones. Under the circumstances, any relationship you might have with Bank of America is a purely transactional, purely commercial one and if you treat it as anything other than that you’re being a sucker.

My local Wal-Mart has a number of consumer electronics items that I’d enjoy owning. And I’m a pretty smart guy; I’m pretty confident I could figure out how to sneak them out of the store without paying for them. Moreover, Wal-mart is among the nation’s worst abusers of eminent domain for private profit, which I regard as little better than legally-sanctioned theft. So in a sense, shoplifting gives Wal-Mart a taste of its own medicine.

Yet I’m not planning to shoplift from Wal-Mart. And the reason I won’t isn’t only, or even primarily, the relatively small risk that I’d get caught. Partly I don’t shoplift because that’s not how I was raised. And partly I don’t shoplift because I understand that a culture in which shoplifting was condoned by most people would be a poorer society. If shoplifting were widely condoned, retail establishments would spend more resources on security, and they would be forced to treat their customers with greater suspicion. I don’t want to live in that world, so I respect Wal-Mart’s property even when it’s not in my interest to do so, and even though I don’t personally like Wal-Mart very much.

In college, I had a friend who occasionally shoplifted. I wasn’t shy about voicing my disapproval of this practice, and I would have cut off friendship with him if he kept doing it. This anti-shoplifting norm benefits everyone. The stigma against shoplifting is a much more powerful, and less costly, check on the behavior than anything that happens in the formal legal system.

I think the same basic analysis applies to defaulting on a mortgage. Personally, I wouldn’t do it (unless I had no choice) because that’s not how I was raised. And I think it’s a good thing that defaulting on a mortgage carries a stigma. The existence of social pressures to pay mortgages has the same salutary effect on the mortgage market that the stigma of shoplifting has on the retail market: it relieves pressure on the formal legal system and allows businesses to be more trusting of their customers. I suspect that if everyone adopted Matt’s attitude toward mortgage defaults, interest rates would be higher and there would be more people who wouldn’t be able to get a mortgage at all, because they couldn’t scrape together a down payment.

Now maybe stealing is in a different moral category than promise-breaking. But if so, then advocates of guilt-free default need to articulate exactly what the difference is. I don’t see how it could turn on whether the harmed party is a “publicly traded for-profit corporation.” The long-run costs from both shoplifting and mortgage defaults are borne not just to shareholders but also to the broader society in the form of reduced public trust. I plan to pay my debts and pay for my purchases. If that makes me a “sucker,” so be it.

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19 Responses to The Ethics of Mortgage Defaults

  1. Tom says:

    I agree with a lot of what you’ve said here, but I’m not sure that the shoplifting intuition pump operates perfectly cleanly. For one thing: we’ve collectively decided to make one of the two actions illegal. There’s a reason for that.

    Which brings us to your assertion that “advocates of guilt-free default need to articulate exactly what the difference is”. I agree! Here’s my attempt: in shoplifting, assets are flowing in a single direction. That’s not the case with a foreclosure. The lender *should* have figured out what the worst-case scenario was, and made sure it could live with possession of the property if the deal went awry.

    If the parties have behaved thoughtfully, once the situation takes a turn for the worse the losses should be apportioned in a way that isn’t devastating to either of the involved parties. But let’s be practical: in general, the lender will be in a better position to absorb the losses. They’re bigger. Their shareholders will be richer. They’re receiving public support. The borrower will suffer some sanctions in the form of higher credit costs, which will discourage further risky behavior and pay for some of the future credit failures of others.

    I think that’ll be enough. So I’m not too bothered by Yglesias’s analysis of the situation. And there’s also something to be said for allowing property prices to deflate by this type of action, rather than effectively garnering workers’ wages to prop up the remnants of a bubble — though obviously that’s a whole other can of worms.

  2. Sarah says:

    Tom, I don’t understand the “flow of assets” argument. What if a shoplifter left cheap keychains or other trinkets in place of the valuable electronics? Would that be better because assets flow both ways? Both Wal-Mart and the bank end up poorer.

    You could also say that Wal-Mart should anticipate shoplifting and make sure it could deal with the loss of its property, and with the possibility that people might leave keychains and abscond with the merchandise.

  3. Jed Harris says:

    I’m not sure how I’d act if my house was way underwater, but I don’t see the issue as parallel to shoplifting at all.

    Regarding mortgages, you say they are promise-breaking. But I think a key question is “What have you promised?” Note that while mortgage lenders technically could force you to pay or go bankrupt, in practice they don’t pursue that option. So the real promise they claim you have made is something like “I promise to pay you $x / month, or give you ownership of my house.” And people who engage in strategic default are keeping that promise.

    I agree about the implicit social values of not shoplifting. But in the mortgage world, and a lot of other domains, the burden of values seems extremely asymmetrical. Goldman Sachs can default on mortgages without condemnation — in fact they are arguably required to by a fiduciary concern for shareholder value, regardless of social impact. Walmart can keep its employees a few hours a week short of benefits, again as a corporate imperative. And mortgage companies can get individuals to sign papers they don’t understand based on misleading claims, again to maximize profit. So apparently we don’t (in practice) feel these entities bear the same responsibility for maintaining social values that we do as individuals.

    I’d unequivocally support moral responsibility by individuals in these relationships as long as the same level of moral responsibility attaches to the other end of the relationship. Your argument about enforcement costs implies that corporations must care more about social well being than straight profits, or we are headed for the dystopia you allude to. Conversely, I’m not at all pleased by the prospect of individual “moral disarmament” in the face of corporate value free decisions.

    I’m not sure how to make this work in practice but the answer of course is not mainly new rules. To begin with we can agree that corporations can’t just be run in the interests of their shareholders, that they must respect all their stakeholders (i.e. everyone they’ve given implicit or explicit promises to). We can use bad publicity, public outrage, boycotts, etc. to enforce this once enough people are in rough agreement on the basic idea. We may also need to get rid of any laws that give shareholders stronger rights than other stakeholders, and perhaps override case law to that effect.

    But I think the key point is the change in attitude. We’ve tried the “value free” approach and it has just the problems you describe, except on a much larger scale.

  4. cryptozoologist says:

    when a mortgage is taken out, the borrower agrees to a giant contract that no one actually reads prior to signing. ask yourself, when i was at my closing, did i take the time to read every single piece of paper i signed? really? did i make all parties sit at that table for 6 to 8 hours while i pored over every piece of paper? the answer is of course not. if you say you did you are likely a liar like this guy:
    these contracts are constructed by the finest legal minds the richest financial institutions can afford to protect their interests.

    now if a borrower walks away from his or her mortgage then the lender seizes the asset that secures the loan (the house) and all parties to the contract are within its terms. i am a little unclear how anyone is acting in an immoral manner.

    how come when a corporation acts purely in the fiduciary interests of its principle stake holders (owners) then we are witnessing a libertarian ideal but when a homeowner does the same he is to be shamed and condemned?

    guess what? banks default on deals that are the equivalent of underwater mortgages all the time. have a look at this:

    lets consider a hypothetical situation of a homeowner that has purchased a home for $750,000 two years ago, but now finds it is worth $460,000 (there are plenty of real cases that are far worse) i submit that the primary reason for the discrepancy is usually the fact that the banks are not interested in renegotiating loans but are eager to forclose, thus bringing down the value of the surrounding real estate. keep in mind that the bank not only gets the house but they also get to keep all the payments the buyer has made. where is the immorality?

    is bankruptcy immoral? the purpose of bankruptcy is to protect people who have taken a risk and failed from ruining the rest of their lives. let me ask you tim, if you were ever to declare bankruptcy, would you labor the rest of your days to make your creditors whole? anything less would be immoral by your standard.

  5. I’m at a bit of a disadvantage here because I’ve never taken out a mortgage so I don’t have first-hand experience with what’s in the fine print. Jed, I suppose it’s possible that some mortgage agreements take the form “I promise to pay you $x / month, or give you ownership of my house.” And if so I guess I don’t have a problem with default. I don’t think that’s what the comments normally say, though.

    cryptozoologist, I haven’t read all the paperwork involved in a mortgage, but I do read every word of most contracts I sign, including leases and writing contracts. I even make rental car companies stand there and watch me read their rental car agreements–I figure that if they’re going to hand me a 4-page contract, they can pay their rep’s salary while I read it. Given that magnitude of the obligation a mortgage represents, I don’t think it’s at all unreasonable to expect someone to spend several hours reading and understanding the fine print.

    As for corporations acting immorally, I’m not sure what the point is supposed to be. I think corporations should probably keep their commitments too. I’m not an expert on commercial real estate so I don’t know if the HuffPost’s characterization of the situation is accurate. If it is, then shame on Morgan Stanley. But the fact that some companies behave unethically doesn’t absolve individuals of responsibility. Again, I’m appalled by Walmart’s abuse of eminent domain, but that doesn’t justify me giving them a taste of their own medicine with the five-finger discount.

  6. Sarah says:

    The deal is not “either you get money or the house”. The house is security. The clause in the mortgage that lets them take your house is like letting them hold onto your driver’s license. It’s an assurance to them that you will fulfill your part of the bargain (pay them everyone month).

  7. Sarah says:

    Analogy to renting: You sign a lease and give a $600 deposit. If you stop paying, the landlord gets to keep the $600. But the deal was for you to pay the whole year.

  8. Sarah says:

    Likewise if Walmart asked for a $10 deposit upon entrance to be returned to you at the checkout register. If people shoplifted, bypassed the checkout line, and let Walmart keep the $10, Walmart would be worse off. If a lot of people did that, Walmart would have to take even more drastic security measures and treat everyone with distrust.

    Leaving security is not a license to run off without paying–in stores or with mortgages. If everyone lets the store/bank keep the security because they don’t keep their end of the bargain, we’re all worse off.

  9. Luis says:

    Your analogies are broken, Sarah. In a mortgage, the deposit isn’t chosen at random ($600, or $10, or whatever.) Instead, the bank pays a professional valuer to look at the house; the ‘deposit’ of the collateral is carefully analyzed to make sure that it matches the value of the loan, with the bank taking on not some random risk ($600, $10, whatever) but the very specific and known risk that the house is worth less than the appraiser appraised it for; in exchange for the profit of your interest payments the bank takes on the risk that (1) you’ll default and (2) if you default, the house will be worth less than they appraised it for. That is the essence of the commercial transaction which is going on, and the banks are very well prepared (and have strong commercial incentives) to appraise both the borrower and the house during the mortgage process.

    But of course during the bubble those incentives were pretty skewed. Lenders had heavy incentives to encourage borrowers to borrow more, and no incentive to pay any attention to the fact that home prices:median household income were two standard deviations above the historical average (because if they paid any attention to that little detail they wouldn’t have had as many mortgages to turn around and sell to the repackagers.)

    So during the bubble both homebuyers and the mortgage companies made a bet that home prices would stay high. There is no a priori reason to place the moral burden for that failed bet on homebuyers who mostly had no expertise in this area; and lots of reasons to place the burden for that failed bet on the experts who had lots of expertise and data at their hands when making that bet.

  10. Pete says:

    “I suspect that if everyone adopted Matt’s attitude toward mortgage defaults, interest rates would be higher and there would be more people who wouldn’t be able to get a mortgage at all, because they couldn’t scrape together a down payment.”

    I’m not sure whether that’s a bug or a feature: shouldn’t the overall effect of that be to cool the housing market, making mortgages more affordable and preventing housing bubbles in the process.

    Also, I think Jed’s point about business and self-interest is well taken. If we’re going to say that the market can’t handle the problem, so individuals have an obligation to stop acting in their best interests (without breaking the law) and look to the collective good, then I can’t see why that argument doesn’t extend to businesses.

  11. Sarah says:

    Luis–Do you really think landlords choose security at random? They take into account the risk that you might renege, and how much it would cost them to advertise and show the apartment again. Just like how banks account for the risk that they might end up with the house.

  12. Tom says:

    Sarah: you’re conflating a few things with the renter example. There is the security deposit, which, to my understanding, typically covers damage to the property. There’s also the option to require first and last month’s rent, which should protect the owner from some of the cost of finding a new renter. Finally, it’s not uncommon for there to be additional obligations attached to breaking a lease — often the owner is in the driver’s seat, and can hold the renter liable for the full cost of the lease (more often they use their leverage to negotiate a mutually agreeable settlement).

    And again: in the case of a mortgage default, the bank has typically already made some money (interest is paid off before principal), and then owns the property outright. It’s still quite possible for this to be profitable, even in a down market.

  13. Mike says:

    As both a mortgage-holder and a Landlord, I’m qualified to comment on a couple of points here.

    – Debts are categorized as either “recourse” or “non-recourse”. Under a “non-recourse” debt, the lender may look no further than the collateral at hand. These are rare in personal loans, but common for businesses. Under “recourse” debt, after seizing and selling the collateral, the lender may still pursue other avenues of collection to make themselves whole. A car loan is typically “recourse” as are your credit cards.

    – States fall into 3 categories with regards to statutes governing residential mortgage:
    (1) All residential mortgages are non-recourse. That is, when the banks take the house, there is no longer an enforceable legal debt.
    (2) Banks may choose either: (a) An expedited and cheaper foreclosure process (usually called non-judicial foreclosure), but in so doing they forgo the enforceability of the balance, or (b) A lengthy and expensive process (called judicial foreclosure) under which they eventually get the house and a judgment for the balance. As a practical matter, the bank almost always picks (a).
    (3) States that are silent on the matter, in which case the mortgage contract is generally full recourse – that is, after taking the house they may pursue a judgment for the shortfall and enforce the judgment.

    Because of this difference in statute, mortgage rates vary from state to state. One can argue that part of what the Arizona resident (case 2) is buying when their mortgage costs 0.25% more than the New York resident (case 3) is the fact that the borrower’s losses are limited to loss of property in Arizona, but not in New York.

    In retrospect, the lenders grossly underpriced this risk premium from state to state, but as much as walking away feels wrong, there is an actual statutory difference (at least in Type 1 and maybe Type 2) states between that and stealing.

    – With respect to security deposits. In many states, there are statutory limits on deposits, which I view as a gross interference in the marketplace. Even where they are not present though, as a practical matter, a landlord can rarely charge “enough” of a deposit, because the pool of renters tends to have nothing in the bank. My properties (single family homes) range from $850-1000 per month in rent, and I charge identical deposits. That deposit is a dealbreaker for about 1/2 of the prospects, yet that deposit would only cover (in the event of eviction or skip out) the single month’s unpaid rent and leaves nothing for cleanup, collections, court costs, repair, etc. A typical breached lease is about $4000 of losses – I typically sue for the balance and relentlessly pursue for collection (realizing about half), but I’m the exception.

  14. Jon says:

    You’re making a huge, huge category error here. A mortgage is the security for a contract. Shoplifting is a crime. Breaching a contract is not a crime. If it is a coupled with a security interest—collateral—in real or personal property, then that’s the deal.

    Why should the banks get more than the benefit of their bargain when you never will? They bargain for a risk premium and security….

    …somehow, I’m sure these points just won’t matter. At the end of the day, it is what it is and people can either choose to run their personal finances like business and win, or adhere to someone eles’s code of morality and lose.

  15. Don says:

    Others, including Jon right above, point out the massive failure of shoplifting as a parallel to mortgage default. So I won’t bother with that.

    I will mention what nobody seems to have brought up in the comments above in response to Sarah’s just as flawed parallel to renting: in most states the security deposit is not the limit to what a landlord can attempt to reclaim if someone skips out on their lease. Any of you who have leases should look at them – you’ll find that the language says your landlord can pursue you for any unpaid remainder.

    In many states it’s not too challenging to sue the renter and get a judgment, which, depending on the state, can be renewed periodically and interest charged. It may or may not be worth a landlord’s while to do that, but there are additional recourses. The same sort of fact applies to other unsecured debt such as credit cards.

    I came to this article and comment section really hoping someone would make a compelling argument for the other side, but I don’t see it here. I continue to think that it’s unreasonable and actually sub-optimal for there to be this imbalance in moral imperative between citizen borrowers and corporate lenders. It certainly didn’t help to have the proponent for this moral imperative admit that he’s never even looked at a typical mortgage agreement.

    There may be some overall benefits to society if people continue to embrace this imbalance (though I think it also prevents other positive effects like better action from lenders) but that’s no reason to hold them to a standard above and beyond the law that their counterparts aren’t held to. When we start discussing the things corporations should do in violation of their interest but for the good of society then perhaps I’ll be willing to revisit the subject.

  16. Serious says:

    You lose all credibility though, when you say — in the comments — “I’ve never had a mortgage.” It explains your position better, but you’re just theorizing based on a reality you can’t conceptualize. Of course, that makes you just like most policymakers.

  17. ripped off says:

    Your an ass!u
    Your statements play into the hands of the predatory servicers and lenders. Which included $100 per cent of the industry. From the small time rip off artists to Wells Fargo and your other ‘business parters’.

    Write about something you know about. Not about mortgages.

    Stephen in California

  18. ripped off says:

    Your an ass!
    Your statements play into the hands of the predatory servicers and lenders. Which included 100 per cent of the industry. From the small time rip off artists to Wells Fargo and your other ‘business partners’.

    Write about something you know about. Not about mortgages.

    Stephen in California

  19. ripped off says:

    Your an ass!
    Your statements play into the hands of the predatory servicers and lenders. Which included $100 per cent of the industry. From the small time rip off artists to Wells Fargo and your other ‘business partners’.

    Write about something you know about. Not about mortgages.

    Stephen in California

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