Sunday, January 31, 2010


One of the byproducts of the recent financial turmoil has been a precipitous drop in home values in the United States. As a result some homeowners are finding that the value of their houses is less than the amount they owe on their mortgages.

A reader from West Virginia writes inquiring about the ethics of homeowners who default on mortgages that they can still afford to pay, but choose not to, because the underlying property values have dropped so precipitously that it is financially preferable simply to walk away.

"Is this kind of `strategic default' blameworthy because it constitutes a failure to keep a promise?" my reader asks. "Or, since the borrower is willing to accept the contractually mandated consequences of defaulting, is it simply a reasonable economic response to the invisible hand of the marketplace?"

My reader is not asking whether a cost/benefit analysis justifies doing something illegal or dishonest, as one reader did recently after I wrote a column in which I held that falsifying or embellishing information given to a landlord is wrong. After that column appeared, one reader e-mailed: "I had a professor ... who once told me that `The cost of not lying on a resume exceeds the cost of lying.'"

His professor's point, that reader wrote, was that, if you don't lie in such circumstances, you're less likely to get the job. If you do lie, "then your cost is limited to losing the job you couldn't have gotten times the relatively low probability of being found out."

So, he concluded, "lying is the recommended policy."

From an ethical perspective, such a policy is bankrupt. "Whatever works" is no foundation for an ethical philosophy, and this approach is likely not only to land you in a job that you're incapable of doing well but also to deprive some qualified candidate of the job. Even if it works, which seems unlikely, it's still not close to ethical.

My West Virginia reader's question, however, makes no suggestion of lying or skirting the law. The practice he describes is unquestionably legal. The question is, is something ethical simply because it's legal?

If a homeowner cannot afford to make payments on her mortgage and cannot sell her house at a price that will yield enough cash to pay off the mortgage so that she can move on, she may be left with no choice but to default on the mortgage and turn over the house to the bank. There's obviously nothing wrong with this from an ethical standpoint.

A key component of my reader's question, however, is that he's talking about homeowners who "can still afford to pay, but choose not to." It may be a reasonable economic decision to walk away from the property - after all, who wants to get stuck making payments on something that's no longer worth what you're paying for it? - but is it ethically acceptable?

I think not. A mortgage agreement is not a promise to do one of two things, either to make the payments or to give up the house. It's a promise to make the payments, period. Giving up the house to the bank is a penalty for not keeping the promise, not one option within the promise.

In this regard the situation is comparable to the law: The fact that the law provides a penalty for, say, stealing someone's car doesn't mean that a person can ethically choose to steal the car if he is prepared to accept the penalty. The requirement of the law is not to steal the car, and the implied promise of citizenship is to obey the law, not to weigh the costs and benefits of breaking it.

Every mortgage comes with the risk that the value of the home may go down during the course of the mortgage, and the homeowner knows that going in. It's true that, for a number of years prior to the current crisis, home prices reliably increased, but there's never any guarantee of that.

The homeowner promised to make the payments, in return for which the bank advanced the purchase price of the house. The bank has lived up to its share of the agreement, and the right thing for the homeowner to do, if he can afford to make the payments, is to live up to his end.

From a practical point of view, to default on the obligation would wreak havoc on his credit rating - but, even if that weren't the case, he still has made a binding commitment. He should honor that commitment as long as he's financially able to do so.

c.2010 The New York Times Syndicate (Distributed by The New York Times Syndicate)


Anonymous said...

The mortgage contract comprises three basic heads of agreement for the security of the contractual undertaking;
1) monthly debt servicing repayments
2) pledge of collateral (property)
3) commitment to repay

Thus choosing not to repay is both breach of contract and breach of the ethical undertaking between parties to the agreement

The lender is not satisfied or protected by recourse to the collatreral through repossession- the loan is made on the basis that there will be no repossesion- the lenders' business is not repossesion but lending- forcing the lender to repossess is forcing upon them with costs and losses that is damaging to their interests

Anonymous said...

Calculate the cost to the lender of goıng through a repossessıon on a sıngle property-

Perhaps ıt ıs 10-15000 ın legal and other fees

Now ask yourself ıf you would be prepared to pay that amount in fees 'upfront' to the lender BEFORE obtaining the mortgage loan in the first place

As that would be the outcome if lenders were to price your 'ethical default risk' ınto the cost of their mortgage loan products

So for example, the situation would be having a mortgage with artificially low subsidised mortgage rates (such as we have now at say 1-4%) PLUS a one off opening fee of 10-15000

Is that a price that is worth paying for a loan, in a society that has ethically accepted breach of contract as the norm?

And if you understand this equation then you understand why banks are reluctant to lend to corporate SMEs at arifically low and subsidised interest rates-

Authorities and regulators can subsidise lower interest rates all they like, but that will not succeed in forcing one party to lend money to another

When policy makers get to grip with this basic issue then our bank lending system will begin to return to a sustainable state of affairs