Ethics: Strategic Mortgage Default Revisited

We recently did a show on the subject of the ethics of abandoning a home because your mortgage is so much greater than the equity of the house. My view was clear and adamant that doing this out of financial opportunity rather than out of necessity is morally unacceptable because you made an agreement. But having read several articles on the subject recently, I wanted to talk about it some more with you and see whether this same stance is still appropriate.

Links:
Underwater, but will they leave the pool? (NYT)
Underwater and not walking away (Paper) (Brent White)
Citi to let distressed homeowners stay 6 months (USA Today)
No help in sight, more homeowners walk away (NYT)
Duplicity in mother of all mortgage walkaways (MSNBC)

Email exchange:
Below is a rather lengthy email conversation I've been having with a friend after last night's show. I decided to post it here instead of just in the comments section mostly because that would take too long (breaking it up into chunks small enough to post) and because I think it's probably interesting enough that I'd like you to see it more easily. So, here:

Andrew,
My schedule has changed so I haven't heard you as much lately. I happened to tune in tonight while you discussed the ethics of abandoning a house. I was really baffled by the conversation.

What I heard was something like this. "Well, you signed a contract with lots of caveats in it, so if you go with the caveats rather than paying for the house, why would that be wrong?" I would imagine in a world of non-Christians that would be a perfectly suitable approach. "Well, the bank approaches it that way, so why shouldn't I?" But from a Christian perspective, I don't even get the question.

Why do we sign contracts? Are we signing contracts to buy a house on the premise that it will make us better off financially and if it doesn't we're free to ditch it, or are we signing the contract on the premise that we'll pay for the house? And why are there caveats in contracts? Are they there because the bank wants to be nice? "Yeah, we know that it might be better for you to get out of this, so we'll give you options." Or are they giving you a disincentive to bail? Do you genuinely believe that contracts are complicated because the bank knows you might want out, or are they complicated because too many people fail to pay?

The person with whom you were speaking/agreeing said, "Of course, if you walk, you'll lose reputation and credit score" with which you agreed. I would think that this alone would answer the question. We are commanded to let our lights so shine before men that they would see our shrewd business practices in weaseling out of a contract that isn't in our favor and glorify ... oh, wait, that's not right. No, we are supposed to represent Christ. We are supposed to be people of integrity. What, for instance, is a "credit score"? It is a financial number that is used to quantify your economic integrity. "Can this guy be trusted?" A hit on a credit score (especially because we choose to default on a loan) is a blatant response: "No!"

Jesus told us to avoid swearing (no, not saying naughty words, but promising ... you know, like signing contracts and such) because we should be people of such integrity that when we say "Yes" we mean "yes". No one signs a house contract with the idea of "maybe". We are promising to pay. Shouldn't we let our "Yes" be "Yes"?

I cannot see a case where someone abandons a home, skips out on payments, stiffs a creditor, and we come away saying, "Now, that is a fine example of Christian virtue." Is abandoning a house moral? Yes, of course, as long as you define "moral" as " conforming to a standard of right behavior of the culture". But we're not held to that morality. We're held to something else. Even if it hurts.But, hey, that's just me.

Stan
http://birdsoftheair.blogspot.com/

Stan,

I like your insight about the credit score as reputation.

I also like your application of letting your light shine.

I don’t see you dealing here with the question of Arizona law specifically being designed to protect you in abandoning your mortgage. Nor do I see you dealing with the question of banks making predatory loans at 35:1 price to rent ratios and adjustable rate loans that depend on people being able to refinance them later as the price of the property goes up. I also don’t see any consideration of the sales approach that “your house is your best investment and will always go up in value.” If a bank loans you money on a commodity which it has a realistic expectation will be worth much less in the near future without warning you of its knowledge, is that still a loan you owe for or is that fraud? Is that predatory lending?

I’d also like to get your take on the question of whether the 15 or 30 year loan isn’t usurious and contrary to the concept of the year of release in Deuteronomy 15. We don’t allow people, for instance, to sell themselves into slavery precisely because we think that some (even voluntary) transactions are unacceptable with the concept of human dignity. Is a home mortgage in this same category? I don’t know, but let’s just say that at the moment I’m highly suspicious.

See, I think the Bible is very careful about restricting the rights and privileges of the wealthy (what is a bank?) against the ordinary citizen, especially the poor one. As a matter of fact, I think the best solution here would be that banks would allow people to walk away without having to foreclose (as Citi has recently started doing, even with letting people stay for a time and offering $1000 in relocation costs).

If the value of housing had simply gone up and up, we naturally wouldn’t be having this conversation. And certainly I’ve often said that people are foolish for believing that you can buy a car and it depreciates while you enjoy the benefit of using it whereas you can buy a house, enjoy it, and still make a profit. But that’s the sort of thinking banks have historically encouraged and profited from encouraging. It’s just not obvious to me that things are as simple as you say (or as I said six months ago, virtually identical to you) nor that banks are currently shouldering their fair share of the burden of the collapse in the real estate market.

By the way, your description of “stiffing a creditor” is fairly well-crafted loaded language. The loan is secured by the house, right? So the creditor in making the loan is saying, “you get the loan and repay it, or else I get your house.” He’s also making a sort of bargain in requiring this security as opposed to merely a promise. If I say to my son, “Do the dishes.” I expect him to do them. If I say to him, “Do the dishes or else you don’t get dinner,” and he says, “Well, I’m not hungry anyhow,” I can’t be all that surprised that he took a deal I offered him. Any time a deal is presented as a trade, the moral obligation is automatically lower than a deal presented merely as goodwill or honor.

I think your most compelling point is about whether we could ever look at someone who walked away from a mortgage electively (not in real need) and praise it as a great example of Christian virtue. I actually know someone who is considering precisely this so that he can relocate to a poor area of town to do ministry with the money he will save. I know someone else whose condo went from $120 K to $24 K (he still owes over $100K). He has bought a foreclosure and intends to just give back the keys to the condo. Now, is he being financially wise under the circumstances? Is he practicing the virtue of looking out for his own family? Or is he just a deadbeat who’s breaking a deal and ruining his Christian reputation? I know he has agonized over the question. Is the bank behaving Christianly if it refuses to negotiate down the loan? What if it tries to foreclose on a house when someone just can’t pay, especially under the ordinary circumstances of increasing prices? When Zaccheus came to know Christ, he gave away half his fortune and paid anyone he had cheated 4X what he took. Paul told Onesimus to return to his master, but he also told Philemon to be kind to his reunited slave. But Jesus was rebuking the Pharisees over the widow’s mite. He most certainly was not praising them for standing by and allowing her to be abused by their teachings about tithing. I worry that we have emphasized so much the idea of maintaining honor as a matter of pride that we are creating a situation which perpetrates financial abuse through moral leverage.

I strongly prefer a society where people pay their debts and honor their word, obviously. I also prefer a situation where the people who own their homes outright aren’t the ones who suffer most from their prior responsible behavior. (Remember that I actually own a home and rent our one here, so I’m speaking as a person most likely to be adversely affected by another round of devaluations.) But banks have essentially built on the personal pride aspect of home ownership developed over the 20th century even as they allowed and profited from pure housing speculation. When a speculator lets a house go because it’s financially foolish to keep it, that’s just business. When a homeowner has been trained to think of himself as a housing speculator (on his own house), suddenly he’s a cad for doing the same thing? Financial transactions always entail risk and they are made for the purpose of profit. Should homeowners not be allowed to cut their losses of equity already paid? Shouldn’t banks have been more careful to get enough down on the loan to make even a market collapse (to 15:1 for instance on value to rent) still a good deal for them? Who should take the brunt of the responsibility and the pain here? “Be a good Christian, just endure, it’s your cross to bear?” How sure are you that’s Biblical advice? Have homeowners been swindled? That’s a strong view to take, but if that were the conclusion, things start to look far less obvious.

The thing I’m getting at, Stan, is that this is significantly more complicated than you are saying. Although, again, I completely understand the impulse to reduce it to a simple moral prohibition since that’s what I thought as recently as a month ago. So, I don’t expect you to be persuaded necessarily. And I don’t expect myself to not be persuaded out of my current view. I may well be wrong. There’s certainly something compelling about the simplicity of your view. But there’s a lot more discussion that needs to happen beyond, “Don’t be a deadbeat. Keep your word.”

Thanks for the conversation and pushing me to think about this more. I will continue to do so, especially because I’m not sure about my own view and it does seem contrary to fairly clear traditional ideas.

May I post your comments on the website?

Andrew,

If my comments would be of value, feel free to post them on the website.

I do have a question. The question of predatory lending, the morality of banks, and all that keeps coming up. I wonder if we are allowed to determine what is genuinely ethical based on sinners, or are we supposed to determine what is ethical based on what is right? (By the way, no one is obligated to buy a home with 35:1 price-to-rent ratios and adjustable rate loans. We aren't obligated to buy a home at all.

I'm wondering the reverse question as well. If a bank wrote a loan with the reverse language in it -- "We may, at any time, choose to no longer fund your loan. If housing prices continue to rise and we determine that it would be more economically in our favor to foreclose on the house and resell it, we may. We will incur xxx penalties for doing so ..." -- how many people would sign that loan?

Okay, more than a question. #3: You said that if people did this (let's assume a lot of highly moral people saw it the way you are describing -- a wise and ethical move), it would have catastrophic effects on everyone. It's okay (ethical), though, if only small numbers do it?

Oh, and, hey, I have a question from ignorance. You may or may not know. When a house is funded for purchase, a bank pays a sum on behalf of the buyer for the house. Some money has changed hands. When I sold my condo in CA, their bank paid off my loan (and then some). So when a home buyer buys a house from a builder, for instance, the bank gives the builder the money on behalf of the buyer and then waits for the buyer to repay that loan. Now ... the house that originally cost $200k is now worth $100k and the buyer walks. The builder is holding $200k from the transaction. The bank can get $100k in the foreclosure. Doesn't the bank lose $100k? (I know, I know, there are payments and interest and all, but I'm just asking about where the money goes and who loses in a foreclosure.) It seems as if someone has to lose something somewhere. Who is it? (It seems like that should be part of the ethical question.)

I know the rules. No email conversations. I don't expect a reply. And that's good because I'll just assume I won! (I'm kidding.) I just can't see determining what is right from the evil that others do ("Is the bank behaving in a Christian manner?" No, of course not! Should I expect them to?) or solely based on what is economically wise. Oh, and thanks for the compliment. I pride myself on "fairly well-crafted loaded language" without going too overboard. ;)

(Oh, by the way. If we are talking about a bank like Citi who allows -- even encourages -- people to do so, it's another ball game.)

Stan,

Your first comment is a false dichotomy, again with loaded language. “Either learn from sinners or do what is right?” You’re trying to be cute, but it’s not so helpful.

Agreed that no one is obligated to buy a house in the first place, but we still say that some voluntary acts are still illegitimate. Or are you suddenly for gay marriage and prostitution?

The question of reversal is better put this way: How many banks would agree to loan a mortgage knowing that a borrower who saw his house decline far enough could simply walk away from it with only a credit score penalty as a consequence and the bank would get the home as collateral? I put it to you that this is precisely the deal every bank accepts when it makes a loan, and they know it. They’re just hoping that the prices won’t go down so much and that even if they do people will still pay nevertheless, just as borrowers are hoping they go up and they can continue to pay. How many buyers would have bought homes in 2005 (or refinanced them along the way) if they had any realistic expectation of losing 50% of the value over the next three years? 10-15%, sure. But 50%? I doubt anyone would have.

I agree with your concern about the collective effects being bad. But I also wonder how much farther housing prices could drop (along with people leaving ownership for rental) before the rental market really started to surge, thereby driving home buying back up. Such interactions are very complicated, and even I don’t pretend to grasp them all. It’s possible that a massive wave of walkaways wouldn’t even have much net effect over a few years, but again, I’m no expert. Then again, it’s not always good analysis to imagine what would happen if everyone did this. Kant isn’t a great guide in all cases. I, for instance, never buy a new car and I almost never buy new clothes. If everyone did either of these, the resale market for clothing or cars would eventually go away. So I’m clearly parasitic upon other people’s financial foolishness with clothes and cars. Does that make my thrift wrong?

Another wrinkle to all of this is the existence of mortgage insurance which compensates a lender in the case of a default, and it’s been my understanding that some banks aren’t willing to do some short sale deals precisely because of the availability of mortgage insurance. Also, I believe carrying homeowner’s insurance is another requirement for mortgages, precisely because the bank wants assurance that uncompensated destruction of the asset is not a likely outcome.

Absolutely the issue of who is losing money is a part of this equation. I’ve been working on the presumption that the bank is the primary loser. And the idea that they would seem to be taking all the loss on their side also bothers me. But so does the interest they charge and their overall pattern of seemingly usurious profit ($200,000 interest over 30 years for a $100,000 house makes me ill to consider).

Again, I want to reiterate that there is a nice clear visceral sense that if you can pay the debts you freely incurred, you should do so. I certainly share the gut instinct that the more financially secure someone is, the less justified they are in walking away from a ridiculous mortgage. Similarly, I expect you share the notion that if a person is in trouble, the more severe the trouble the more acceptable this option becomes morally, just like bankruptcy as an extreme case. So there’s something funky in the idea that people in trouble have moral justifications that others do not, but that’s often the way of things. I can’t get free food from the government because I earn too much, for instance.

Aside from the Biblical questions of abuse and lending and release (which you didn’t comment on), I think my two big observations are that the loan is collateralized with a particular thing and that the deal most people think they made in their head (I made a deal with this particular person to get a house and then pay for it) is far more simplistic than the actual legal contract the 50 pages of papers represent and the subsequent sale of slices of that mortgage to secondary investors. I’m just not sure that our moral intuitions for simple interpersonal promises fit the reality of this highly complex situation.

Is a guy who can pay his mortgage and does pay his mortgage morally better than a guy who can pay but abandons it to better himself financially? I’m generally inclined to say he is. What if following that path becomes really harmful to him or his family, even though he could theoretically do it? I’m more inclined to say he is not.

Andrew