THE ETHICS OF ‘WALKING AWAY’ FROM YOUR MORTGAGE
It should be clear to all of us by now that the single driving factor in this economic downturn was the meltdown in home values. All the talk about how the big banks screwed us over is relevant only as it relates to the massive devaluation of our largest personal asset; our homes. If home values had stayed relatively stable, or come down at a reasonable rate, the bank crisis may have been manageable. It may have been seen as a bad couple of quarters rather than the catastrophe it became.
But that didn’t happen so here we are. And where we are may very well precipitate another huge devaluation of homes which would then lead to another round of bailouts and takeovers. This is because according to most experts, there is still slack in home values that has yet to be taken in; that our homes are still overvalued despite dropping 30-35-40%.
This has created a situation that is evidently not unprecedented except in scale; people with “underwater” mortgages - where they owe more than their house is worth - simply mailing the keys to their domicile to the bank and walking away from their mortgage obligations. Many simply stop payments and dare the bank to foreclose and evict them. Others find cheaper quarters by either renting, or taking advantage of cheaper mortgages.
There were a few of these walkaways during the housing bust of the early 1990’s. But today, nearly 5 million mortgages - about 10% of all residential mortgages in the country - are underwater (defined as a mortgage where the value of the house is 75% or less than the principle). And while no one is keeping track, one outfit has estimated that a half million people took the walkaway route last year.
Financial advisors are at the point of actually urging their clients to walkaway. Sure, their credit rating will take a hit. Better that than pouring money down a black hole where you will never realize any return on your investment.
There are a couple of ethical questions associated with walkaways that need to be addressed; one is personal, the other is an apparent double standard in the application of society’s disapproval.
Case in point; a New York developer walked away from paying the loan on 11,000 apartments in Manhattan:
The rules are different, though, for the walkaway of all walkaways.
That title is reserved for what happened to one of New York’s trophy properties, the 56-building Stuyvesant Town and Peter Cooper Village complex. Spanning 80 acres on Manhattan’s east side, it’s the largest single-owned residential area in the city. Its red brick buildings, built by Metropolitan Life in the 1940s for World War II veterans, are still a haven for the city’s middle class.
Commercial real-estate firm Tishman and its partner, investment firm BlackRock, paid $5.4 billion to buy the property from MetLife in late 2006 — right at the market’s peak. They hoped to make money by converting rent-regulated apartments into luxury condos and raising rents.
Then the housing crash hit. The value now: $1.8 billion.
And you thought you overpaid for your house.
“They made assumptions that things would grow to the moon, and things certainly did not,” said Len Blum, a managing partner at investment bank Westwood Capital.
Tishman said last week that it was turning the property back over to creditors to avoid filing for bankruptcy protection. In recent weeks, Tishman failed to restructure $4.4 billion in debt, and couldn’t find another buyer, according to a statement from the company.
Will Tishman come in for less disapprobation than a homeowner who walks away from a mortgage where he is paying 40% more than the house is worth? It’s a certainty that banks are treating Tishman differently than the ordinary homeowner:
Walking away isn’t risk-free. A foreclosure stays on a consumer’s credit record for seven years and can send a credit score (based on a scale of 300 to 850) plunging by as much as 160 points, according to Fair Isaac Corp., which provides tools for analyzing credit records. A lower credit score means auto and other loans are likely to come with much higher interest rates, and credit card issuers may charge more interest or refuse to issue a card.
In addition, many states give lenders varying degrees of scope to seize bank deposits, cars or other assets of people who default on mortgages.
Even so, in neighborhoods with high concentrations of foreclosures, “it’s going to be really difficult to prevent a cascade effect” as one strategic default emboldens others to take that drastic step, says Paola Sapienza, a professor of finance at Northwestern University. A study by researchers at Northwestern and the University of Chicago found that as many as one in four defaults may be strategic.
The double standard is easy to understand, less easy to justify. The fact is, a bank is less apt to severely penalize someone who owes them billions as opposed to someone who is into them for a few hundred thousand. The “sin” may be similar, but repentance is more complicated. It’s as if a rich man and a poor man both stole a loaf of bread; the poor man was forced to knee walk up a rocky mountain and say the rosary while the rich man got away with saying one our father, one hail mary, and a glory be (old line catholics will recognize that penance immediately).
Ideally, the same sin should engender the same penance or punishment regardless of wealth or social station. But in this case, we hold people and corporations to different standards of behavior and hence, different attitudes toward walkaways.
But it is the personal ethics of abandoning a promise to repay monies loaned in good faith by a lending institution based on your past history of good credit and timely repayment that is of most relevance for us. What happens when so many walk away from their obligations not because they can’t pay but because paying what they owe is a bad personal financial decision?
We can all sympathize with the walkaway and wonder if we’d do the same in their situation. But from an ethical standpoint, this is really rotten. By walking away, these homeowners are making it more difficult for the rest of us to get a homeloan or refinance our existing home. This is an inherently selfish act in that the walkaway fails to take into account the effect on the community and society.
And then there’s the prospect if there are enough walkaways, a tipping point will be reached and all that bad paper that is still on the balance books of major banks will cause another meltdown necessitating still more bailouts and takeovers when home values go into another death spiral.
What happens if five million Americans decide to stop overpaying their mortgages and mail the keys back to the bank? There would be a sharp decline in housing values. There would be another downward leg to the financial crisis, with a big hit to the capital of banks and other institutions holding large mortgage portfolios.
I think the housing decline would be a healthy thing, as this market is still overvalued. I don’t believe we would see a deflationary spiral, a widespread collapse of debt values, and a descent into a full-fledged Great Depression II. This was the great fear when the bubble first started popping in late 2006.
But since late 2008, the Bernanke Doctrine has showed that the modern Fed has the tools to keep this from happening. Administration officials can say whatever they want, but Too-Big-To-Fail is still reality.
What of the decline in individual purchasing power, the so-called adverse wealth effect, that would come with lower housing values? It would be muted because making mortgage payments on an overvalued house diminishes purchasing power just as badly.
But the net effect of the Great Walkaway would still be a strong downdraft in the overall economy.
I don’t for a moment believe that 5 million people will strategically default on their mortgages. But who can guess where the tipping point might be? Who can be sure that 1 million or 2 million such defaults wouldn’t crash the economy again?
All because people selfishly took stock of their personal financial situation and decided it was OK to saddle the rest of us with what is, after all, their problem. I say they have no ethical right to do it and that Congress should make it easier for banks to collect from these voluntary deadbeats.
Not surprisingly, Congress will treat these people as victims and no doubt either bail them out (one estimate is it would take about $750 billion to pay off the difference between what underwater borrowers owe and what their houses are worth), or make some accommodation with credit reporting services to give these strategic deadbeats a pass. Encouraging irresponsibility has been the hallmark of the Obama administration housing policies so why should we expect anything to be different here?
For the vast majority of us who have suffered a big hit on the value of our homes but continue to remain faithful to our obligations, this whole walkaway phenomenon is a slap in the face. We are being played for suckers. And it’s depressing to think that rewards will accrue to those ethically challenged scofflaws who don’t play by the rules but come out smelling like roses anyway.
I live in a non-recourse state. My contract states my ability to walk away. I will be doing just that. It may be a slap in the face for you suckers, but you’ll get over it.
Comment by widespreadpanic — 2/4/2010 @ 12:10 pm
The difference between right and wrong is not a contract we make with society. These beliefs are subjective and arbitrary. I never signed a social contract when I reached a rational decision making age, did YOU?
Their is no consensus or unified theory of ethics and this is exactly why I won’t change your mind and you won’t change mine.
This is the classic disagreement of Consequentialism versus Deontological ethics.
Wiki: Ethics, OR summarized “The ends justify the means,” versus, “duty to act regardless of outcome.”
a)(Deontological case) Continue to throw good money at bad down the rabbit hole of underwater mortgage to “honor your promise to pay” to banks that **poofed** 90% of the loan money into existence via fractional reserve banking. Your “honor” gives you value and good “morals.”
OR
b)(Consequentialist case) Break your promise to the bank and vanish X amount of debt from your families finances, enabling a higher quality of life for your loved ones, to whom you hold a moral duty to care for. You will carry the stigma as a contract breaker or one that goes back on your word given certain circumstances.
Which is more right or more wrong? Your belief is as subjective as mine. Except I would say, placed in another man’s shoes, most loving, rational, “moral” men would choose option B.
Fascinating. Rarely have I seen such beautifully constructed sophistry, such complex self justification for what really is a simple question of basic ethics.
There are so many holes in your thesis I was wanting to put it on my bologna sandwich Your loved ones for whom you have a “moral duty” to care for do not need a “higher quality of life” to survive. That’s irrational. It is a choice you make at the expense of the rest of us - again, inherently selfish.
But never mind. If you are trapped in your burning house I am sure you won’t expect anyone to come to your assistance. Why should firefighters risk their lives? After all, they have a moral duty to their families to survive. And if you’re worried about the fact that you pay them to rescue you, don’t worry. I’ll take up a collection after you’ve burned to death and rebate that portion of your taxes. It will be no skin off the noses of the firefighters and besides, it would be what any ” loving, rational, moral” man would do, right?
ed.
Comment by widespreadpanic — 2/4/2010 @ 12:17 pm
I am in a situation where my mortgage exceeds my home value. It is my fault. I refinanced when the property value was higher. I signed a contract agreeing to pay that debt. I am morally obligated to do so. I will do so. The idea of abandoning debt with impunity flies in the face of traditional values. My payments are the same as they were before the crash and my income is the same. I have no justifiable excuse to default on my obligation. I just don’t understand how people can do such a thing.
Comment by Robert — 2/4/2010 @ 12:38 pm
Robert: I’m sure the fact you live in a recourse state has nothing to do with your decision right?
Comment by widespreadpanic — 2/4/2010 @ 1:10 pm
As a long time renter who SOMEDAY wants to buy a home, my interests are in letting the market reach a real equilibrium. It is a long way from that where I live, in Silicon Valley. I’ve watched for years as the prices kept jumping higher and higher, much higher than the incomes. Plenty of people took advantage of their windfall equity increases by driving Mercedes, extensive remodels, vacations, etc, etc.
The prices of homes here are being propped up with MY tax dollars (current and future) in ways that work against my interest.
While a FICO score substitutes for a moral judgment by the community, default is a real option for ALL debtors. There are prices to be paid and the moral calculus must be weighed by all parties.
It’s just business.
Let homeowners default. What will happen is the federal government will reimburse the banks with everyone’s tax dollars or through massive inflation so that their reserve margins keep them in business. After all, the banking/financial system is more important than the housing market.
Someday home prices will match incomes. Until then, I’ll save thousands every month by renting.
Comment by Whitehall — 2/4/2010 @ 1:31 pm
Rick said:
Yeah, you say that, and I say that the banks had no ethical right whatsoever to offer up No Income/Asset/Employment verification loans. A decision that undermined and completely fucked everything.
Voluntary deadbeats? That’s harsh. You’re blaming the wrong people, and not taking into account the lending practices that are at the very root of the problem. The banks were basically GIVING AWAY investor money that was only backed by borrower lies and bullshit… and they KNEW it the whole time. They simply didn’t care, because everyone else was doing it too, and the no-strings commissions were huge.
So, a bunch of people take advantage of what is essentially FREE MONEY.
And now what? We’re actually surprised that people lied their asses off to get a huge home loan they couldn’t pay for? I feel no obligations to any bank who pulled this shit and allowed it to happen. Nobody forced them to make those free money loans. I’d walk away in a heartbeat if I had to.
Comment by Chuck Tucson — 2/4/2010 @ 2:38 pm
“It should be clear to all of us by now that the single driving factor in this economic downturn was the meltdown in home values.”
So what or who caused the ‘meltdown in home values’.
Surely not the Banks or Mortgage holders.
Must be those dopes who forced those innocent and blameless bankers to make those loans.
Comment by BellWeather Bill — 2/4/2010 @ 3:50 pm
We are a nation that no longer casts an eye of shame on those who “walk away” from their spouses and their children. Walking away from a mortgage? Good luck finding many that will call that a moral or ethical dilemma. Morals and ethics are a fabrication of those loony right wingers you’re always ranting about, and they really get in the way of infantilizing the electorate. It’s not our fault, dammit, and Daddy Government’s gonna make it all better real soon.
Comment by Anon — 2/4/2010 @ 4:35 pm
If I incorporated, and then bought the house, then surely society would understand that I have to walk away from my bad investment desicion for the good of my stockholders. In this case the stockholders would be me and my family.
And if the houseing value drops low enough, maybe the folks who walked away from the houses can come back in 5-7 years and buy the property they walked away from.
I say 5-7 years not because thats when the bad marks will be washed off their credit record, but rather due to one of the bank CEOs explaining to his daughter that financial crisis happen evry 5-7 years… mostly due to the so called experts being clueless and greedy. Run the market up as high as possible, and then sell sell sell to some poor sucker. Like all the current ads telling folks to buy gold at record high prices so that folks currently with gold can make big big bucks.
Comment by KenGirard — 2/4/2010 @ 4:40 pm
Dear Widespreadpanic:
Here is another little factoid for your “moral” consideration. When you walk away from a mortgage, it is effectively a cancellation of debt, which can and often is then considered income. Income that is usually taxable income, unless it is a business, a farm, or a couple of other rare exemptions. Let me know how telling the IRS that there rules are subjective and inconsequential with Deontological ethics.
Arrogant and stupid. Not a good combination.
Comment by still liberal — 2/4/2010 @ 5:09 pm
Dear Widespreadpanic:
Here is another little factoid for your “moral” consideration. When you walk away from a mortgage, it is effectively a cancellation of debt, which can and often is then considered income. Income that is usually taxable income, unless it is a business, a farm, or a couple of other rare exemptions. Let me know how telling the IRS that there rules are subjective and inconsequential with Deontological ethics works out.
Arrogant and stupid. Not a good combination.
Comment by still liberal — 2/4/2010 @ 5:10 pm
An individual walking away from their mortgage may be in for a rude awakening years down the road. They may still be responsible for the difference between their mortgage’s amount and what the mortgage holder was paid when they sold the defaulted/foreclosed property. The mortgage holder can file for a judgment against the individual in the amount of the deficiency. if the judgment is awarded they can start the collection process against the individual. This may not happen immediately, they can wait 5 or more years and when the individual gets back on their feet financially sock the individual with the judgment via garnished wages or selling the judgment to a collection agency etc… Unless file for bankruptcy, that mortgage they thought they were discarding may be lurking in the shadows ready to return like a nightmare. defeating the purpose of walking away from the mortgage in the first place.
Comment by Occamsrazor7 — 2/4/2010 @ 6:26 pm
While you grasp the situation well Rick, your summary is not the best that you can do. This paragraph kinda stood out:
Not sure where this certainty re: Congress is coming from, but seeing how poorly the 75 billion already allocated for helping underwater/behind mortgage holders was spent, the chance of more money spent on this are slim at best. I mean, do the Dems really want to add such a thing to their plate this election year, seeing how bad they are at getting anything else done?
You may also wish to look at how many of there “deadbeats” are actually the victims of mortgage fraud and other financial shenanigans before coming to such a sweeping judgement. Not saying we need to have any special help for them (as that would be spectacular government overreach), but the circumstances are hardly black and white here.
Finally, the housing debacle has its roots in the Clinton era and was propelled along by Bush (all the while abetted by Greenspan), so calling Obama irresponsible in this matter is quite partisan. No president or party alone could have fucked up this badly.
Comment by Surabaya Stew — 2/4/2010 @ 7:01 pm
In this country ethics are for the little people.
The GOP has made clear they intend to serve the interests of Wall Street and the banks — even more than the already-supine Democrats.
And Wall Street and the banks have made clear that American citizens and taxpayers can go f— themselves.
Conservatives work like busy little beavers to assist corporations in f—— you, and Democrats are better only in degree, not in kind.
So it’s one great, big, go f— yourself country. If you’re wealthy or powerful.
So don’t act like your betters and cop a “go f— yourself” attitude. Instead Join the Powers That Be and help them in their important work by going and f—— yourself.
When you’re living in a box under a bridge no doubt some banker will toss you his spare change.
Comment by michael reynolds — 2/4/2010 @ 8:33 pm
I think the sucker slapping has already taken place. When the Feds took our tax money (the underwater mortgage folks) and gave it to the irresponsible banks. These same banks are now making record profits using our hard earned money. Who is holding the bag here? Your moralizing is ridiculous to say the least.
Comment by kevin brown — 2/5/2010 @ 3:01 am
Have we been told ? Did I miss it ? WHICH banks were “bailed out “? WHY were these banks selected to be “nationalised”? WHO, in which federal bureaucracy, made the decisions? Shouldn’t we be told ? And WHO is going to tell us? Can we trust what those who made the decision to nationalise the banks tell us ? What a way to live.
Comment by snowball — 2/5/2010 @ 5:53 am
Interesting piece. If non-human persons (corporations) are primarily motivated by greed, it’s good for society, and if if human persons are primarily motivated by greed, it’s bad for society? Different standards of behavior indeed. And where does one draw the line? (As KenGirard notes in passing.)
Personally I am in the “greed is useful, but definitely not good or optimal” camp.
Comment by Bill Arnold — 2/5/2010 @ 10:52 pm
If it is immoral for a debtor to walk away from a house that has dropped in value, isn’t it equally immoral for a bank to hold the debtor responsible for a loan that doesn’t reflect the value of the loan’s security?
Morality in this instance, is not a one way street. Home owners WANT to keep their homes, but when a bank refuses to lower the principal on the loan, or modifies the loan by lowering the interest by a quarter point, but then extends the life of the loan by ten years so that MORE is paid in the long run, it is not financially feasible to keep the home. That is what is happening and it is simply greed on the part of the banks. So then I ask, is greed moral?
In recourse states, is it moral for the bank to get their security, i.e., the house, through a foreclosure, AND get a deficiency judgment against the debtor? Bankruptcy is the ONE recourse the debtor has. The bankruptcy code allows the value automobiles to be “crammed down” to reflect their true value, but explicitly EXCLUDES mortgages from being crammed down. Is that moral? Go talk to Barney Frank and the other geniuses in Congress who thought it was a good idea to change the mortgage rules so that someone earning $12 per hour could get a $100k mortgage.
This is business. Yes, my neighbor’s foreclosure effects me, but then, I should have been smart enough to not buy a home in an over valued neighborhood to begin with.
Comment by Steven — 2/6/2010 @ 11:43 am
Practically, since the economy seems to be experiencing a crest and trough and nobody knows when it will be going up side down, I would rather make an appropriate response to the given situation. If in case it would be impractical to pay my debts then, I will have it foreclosed. This can be done if I could no longer pay my accounts, than saving at the expense of my family. After all I can immediately return the key and make myself free of my obligations and begin anew.
Comment by Mark @ Israel — 2/8/2010 @ 3:45 pm