How the Mortgage Crisis Made Us Immoral
If you own a house and I’m your neighbor, I’ll respect your property rights. It’s just the right thing to do. (Though if there’s a fire at my place, I might break in to borrow your fire extinguisher).
If you live in a nice neighborhood, you have little to fear from the more modest parts of town. (Though if your neighborhood doubles its average income, and the modest part of town doubles its unemployment rate, and you start putting gates around your community—well, you might be a little more fearful).
Which leads us to this US headline from Fannie Mae’s Quarter 1 National Housing Survey:
“Nearly twice as many Underwater Borrowers (27%) think it is okay to walk away from a mortgage if they face financial distress than in January 2010.”
Is this a moral issue? What does it mean that the frequency of the opinion has changed? That it has doubled in a year?
Economics and Morality
Most people still think it’s immoral to walk away from a debt. But those who think otherwise—that defaulting on a payment to a nameless morass of long-since-tranched, securitized asset-owners is as amoral as it gets—have grown by 100% in just over a year.
That’s pretty high growth for the amoral team.
It’s one thing to say that morality should have nothing to do with economics. And indeed, the sense of honor and justice and trust that underpins most moral behavior is socially useful. If we all acted solely in our immediate self-interest in every situation, the world would be a greedy, dangerous, Hobbesian mess.
At the same time, economic disparity writ large spells social unrest. In Greece, they riot in the streets. In Rio de Janeiro, they have a street crime problem.
In the US, we are witnessing a small version of things. People who used to feel a moral obligation to repay a debt are saying to themselves, “Heck, the big guys and companies do this all the time—if things aren’t working out, they just default, take the insurance payment, write it off, whatever. There’s nothing moral or immoral about it—it’s just dumb to do otherwise.”
Economics Can Wear Down Morality
You may think that honoring your debt is a moral issue. You may think it’s not. What’s clear, though, is that the ratio of those two views is being driven by economic changes.
The credit ratings services will take note of this, calling it a likely increase in the default rate, and a cause for downgrading securities.
But the people on the street—in both the nice and the modest neighborhoods—will experience it as a moral casualty of the economy.
It’s just one more area of human relations that will no longer be governed by the rules of “rightness,” but rather by the least common denominator, Darwinian terms of the marketplace.
And that’s not a change to be happy about.
Charlie,
There are probably a number of causes for this behavior but it is still wrong. Economics is based on morality and trust (or lack there of).
As a consumer watching large companies and executives getting bailed out and subsidized the consumer says. “hey they made a bad decision walked away and got rewarded with millions in pay and perhaps even a new job; why can’t I just walk away?”
So what to do? I believe we have to start treating corporations and those that run them like the citizens they want to be treated as. I mean if they enjoy the rights of citizenship should they not also enjoy the responsibilities? As one stark example, If you want to contribute money to campaigns like a citizen then when your firm contributes to negligent manslaughter you should pay the same penalties an individual would.
The consumers see corporations and executives getting away literally with murder on the evening news and they wonder why they can’t just walk away from a mortgage.
If we are all citizens of the society, rich and poor, corporations and main street business then we all have to play by the same rules in the same game.
Charlie –
I’m not very comfortable with equating re-paying mortgage obligations with morality. A poor credit report is mark of poor morality?
I thought you were going to discuss the moral, ethical, and legal problems around the mortgage origination process. That’s where the problems lie. Lenders were entering into contractual debt obligations with people who did not have the financial aptitude or understanding you would expect with giving them hundreds of thousands of dollars.
Mortgages are very clear about what happens if you don’t re-pay. The lender can sue you for the cash and/or can take back the property. Some states have stepped in and prevent mortgage lenders from suing for the cash; They are limited in recourse to the property.
Default rates and repayment rates are well studied by those savvy investors in mortgage-backed securities.
Contracts and contract law, including mortgages, are designed to deal with what happens in the breach of a contract. On top of that, the right to file bankruptcy is part of the constitution. Debtors’ prison was hated by many of the Founding Fathers.
If you lost your job and can’t repay your mortgage, then walking away or declaring bankruptcy are supposed to be viable options.
There is a more interesting thread of discussion for those borrowers who still have the income to pay their mortgage, but are concerned that the debt balance is far in excess of the current value of the home. For them, they have a poor investment on their hands, having lost whatever equity they put down, plus they have to continue to pay the monthly payments.
A strategic default is bit more interesting to think about than someone who just can’t afford their mortgage.
Very interesting.
I think John Gies and Doug Cornelius are talking about very different things, and I’d love to hear them react to each other’s posts.
For my part, I don’t think Doug is talking about morality at all, just about laws. I never suggested that a bad credit rating had anything to do with morality, for example; and while he’s right that there are plenty of unscrupulous lenders out there who behaved badly, I’m not talking about them either.
What I’m talking about first hit me on a news show 2-3 years ago when a San Francisco couple was interviewed on TV talking about how unfair it felt that their credit rating would be hurt when they defaulted on a second-home loan. They both had jobs, drove good cars, weren’t in any serious trouble–it’s just that their second condo had gone underwater, and they figured what the heck time to get out, it’s a purely economic decision. As I said, they felt faintly victimized by the probably impact it would have on their credit rating.
It hit me at that time, these people have absolutely no sense of moral obligation about having taken out a loan. They have outsourced their morality entirely with regard to this transaction. The mortgage to them was nothing more than an anonymous financial transaction, much more akin to buying a forward contract than to an old-style unsecured bank loan. It was completely amoral.
I’m not saying they’re wrong, either; the loan was in fact overtly secured, for example. And the loan was treated no differently from any other securitized transaction. In fact, the system has made all such transactions about as impersonal as possible.
One of the results of that relentless application of financiering and NPV-ing and converting to financial terms is that there’s nothing left of what used to be. JP Morgan was famously quoted as saying he’d lend millions on a man’s good word, but nothing for all the secured assets in Christendom. Look at popular culture until a few decades ago–what does the couple in San Mateo think when they watch It’s A Wonderful Life, replete with people hanging on like crazy to fulfill the moral, financial obligations to each other transacted through the S&L?
Many people used to feel what I call a moral obligation to pay back loans. It had very little to do with the law, it had everything to do with what one “ought” to do as a citizen, a religious person, a member of a community, whatever. It’s what you’re “supposed” to do.
The percentage of people who believe that is now falling rapidly.
Doug, the fact that the law is clear in all these matters has as much to do with morality as a fish has to do with a bicycle. The fact that you can recite all the law around mortgage obligations and never even notice the absence of a sense of personal obligation in connection with repaying loans is, well, actually, a little scary. The fact that the connection seems odd to you is prima facie evidence of how bad it’s gotten, it seems to me. Smart, educated people like yourself seem perfectly happy believing that debt, mortgages, loans, obligations have nothing to do with morality, but are covered completely and adequately by a system of laws.
Laws are made by people; they are frequently changed. Compliance with the law depends on social acceptance of those laws. Slavery was once legal. It was once illegal for women to vote. If you have laws and no social acceptance of them, the laws become worthless.
The entire country of Argentina defaulted on its international obligations a decade ago; what teeth did the laws have then? If the IMF et al insist on bondholders getting their pound of flesh from Greece, Ireland and Portugal, the very real risk is that those bondholders will get very little at all, because those countries will pull an Argentina. In fact, the best way to guarantee they do so is to keep pretending that laws have nothing to do with social fairness.
At the extremes, when laws become uncoupled from morality, you get close to social unrest. And all the recitations of what the law “is” then become irrelevant.
The law strays far from morality at its own risk. In this particular case, we’ve now got nearly 1/3 of the people who are underwater saying that they no longer accept the legitimacy of the laws governing their debt. That doesn’t mean they won’t repay it, though some clearly won’t; but it surely means we have a level of social unrest that is socially destructive.
And as John articulated, when things are that far out of whack, a massive sense of unfairness takes hold. And the result, eventually, is either the laws get changed or ignored. I don’t think people generally settle down and say, well, OK, I guess we just have to be screwed for a few decades. Case in point: Germany after the manifestly unfair Versailles Treaty ending WWI. More likely, things get changed.
I do think that repaying a mortgage, a credit card bill or a hospital bill is in fact a moral obligation. There was a time when business was done on a handshake. It wasn’t so long ago.
Part of the challenge, and it has been articulate far clearer by others, is that when we live governed by laws v. morality, we fall into the mindset of, “We didn’t break any laws.” Even though they may have used dishonest and shoddy practices that required a massive bailout or some other harm against the public or individuals.
Part of the challenge that we have today is our response to every event is to create a massive set of rules to govern the situation. Then a group of professionals will get paid to find work arounds for it that don’t break the law.
Ayn Rand once said that Capitalism is a moral system as much as it is an economic system. I would suggest that economics depend on morality and trust. Where it gets tricky is where we try to legislate morality and or coerce morality.
Not an easy solution. As our societies get larger and more diverse our sense of “common ground” shifts. That just means we have to keep active in the conversation.
Charlie –
I want make sure that we draw a line between breaking the law and defaulting under a contractual obligation. I have my opinions on the fraud and misdeeds that lead up to the real estate bubble and the subsequent crash in prices that have put us in a place where we are debating the morality of strategic defaults. I will leave it up to the prosecutors to start doling out criminal liability. (Personally, I think there was more incompetence and ignorance than criminal behavior at the top; And vice versa at the lower, loan origination level.)
A failure between private parties, with no fraud or misdeeds, is governed by the rule of law in this country. There is an obligation for the parties to live up to their contractual obligations. I consider it a moral obligation and think most people consider it a moral obligation.
If one party fails to live up to the obligations, the other party has certain, limited rights for recourse. It’s a fundamental component of our society that people can get a fresh start. We don’t have debtor’s prisons. I think that’s a good thing. The lender has a moral obligation to not overreact. We do not permit lenders to take a literal pound of flesh.
That ability to walk away from a mortgage is one that would prevent the social unrest you fear. It may cause more economic damage to the banks but I would not equate that with social unrest. In government seem to be forcing lenders to compromise on the debt obligations. The politicians are on the side of the borrowers. (Borrowers vote; corporations do not.)
I also think it’s important to draw a distinction between those who default because they cannot pay, an income default, and those who default because the asset has dramatically decreased in value, a strategic default. The story that you recall is a classic strategic default. They overpaid during the bubble, prices have collapsed and they are throwing good money after bad. To some extent, there is also an element of a strategic default in an income default. If the property were worth more than the mortgage balance they could simply sell the property, repay the debt and pocket a few dollars.
I agree that the securitization of our debts is probably moving our country’s moral compass when it comes to repaying our debt. Largely, we are borrowing from big faceless entities that are repackaging and distributing our obligations. That also means that we are faceless borrowers that are little more than a monthly check. Perhaps people do feel differently about repaying a faceless lender than they do about repaying an obligation to their neighbor.
I see it as a positive sign of morality that the couple in Charlie’s story was having trouble deciding to make a strategic default. The pure economic argument would make it very clear that they should walk away. I think it’s a bit of a unique economic situation where real estate prices have fallen so dramatically that borrowers would even contemplate a strategic default. It’s also a new situation where so much of that debt has been repackaged into a complex morass of securitization. Perhaps there is an opportunity to see what effect this has on the long term default rate of personal debt and home loans.
Charlie, please don’t think that I overlook the personal obligations. I’m buying a new house next week and using my local bank to finance the purchase. I bypassed potentially less expensive alternatives from faceless mortgage brokers because I wanted the local connection. I know that my failure to repay would result in a personal, moral loss every time I walk into that bank. That’s a bank where my kids come in with their savings book and put their tooth fairy money on the teller’s counter. Put me in the “It’s a Wonderful Life” category.
Doug,
Thanks for taking the time to amplify your views, I found it helpful. (And I’m happy that we’re on the same side of George Bailey’s tale).
We both agree that–to use your terms–“There is an obligation for the parties to live up to their contractual obligations. I consider it a moral obligation and think most people consider it a moral obligation.” Me too.
We also agree that it’s a good thing debtor’s prison is a thing of the past, although I suspect we might disagree about the de facto version of the same thing. I have seen poor people enslaved to barely-legal interest rates that bind them for years based on contracts that are flatly illegal in less laissez faire countries.
Your view is that the courts favor the borrowers: that’s true at the 5,00-foot “no debtors’ prison” view. But at the 50,000-foot view, there are a whole lot of permanently house-poor people barely scraping by; meanwhile, Angelo Mozilo and Dick Fuld and all those who sold no-doc mortgages and those who packaged them into tranches and bought and sold them and insured them with swaps–well, we also don’t have lenders’ prison. From my perspective, the law is far more lenient with them.
Just to be clear (I probably wasn’t in the original post) on the TV couple’s situation: they were NOT having a hard time deciding, at least not on moral grounds. That was a piece of cake for them, they had crossed that line a whole lot earlier–they were operating already from what you call the pure economic argument. What they were having a hard time with was the likely resultant reduction in their credit rating, which they considered unfair–after all, all that they had done was to default on a loan! Which, of course, I found ironic and sad.
We both see the moral connection resting in one’s general obligation to repay loans. And we both agree that reasonable societies allow for legal, and I think moral, ways out of untenable situations. My concern is that when you have so many exceptions to a moral rule, the moral rule begins to lose its legitimacy. And in our case, I point to the Mozilo’s et al who shamelessly pushed the law to the edge, knowing they were bankrupting not only people’s financial bank accounts, but our moral ones as well. When an entire industry made so many egregious loans, with virtual certainty they they wouldn’t be repaid, it gives new meaning to the term “moral hazard.”
May the angel Clarence be with you.
Justin Fox, editorial director of the Harvard Business Review Group, asks a related and much more pressing question: What kind of country reneges on its contracts?
Very interesting.
I think John Gies and Doug Cornelius are talking about very different things, and I’d love to hear them react to each other’s posts.
For my part, I don’t think Doug is talking about morality at all, just about laws. I never suggested that a bad credit rating had anything to do with morality, for example; and while he’s right that there are plenty of unscrupulous lenders out there who behaved badly, I’m not talking about them either.
What I’m talking about first hit me on a news show 2-3 years ago when a San Francisco couple was interviewed on TV talking about how unfair it felt that their credit rating would be hurt when they defaulted on a second-home loan. They both had jobs, drove good cars, weren’t in any serious trouble–it’s just that their second condo had gone underwater, and they figured what the heck time to get out, it’s a purely economic decision. As I said, they felt faintly victimized by the probably impact it would have on their credit rating.
It hit me at that time, these people have absolutely no sense of moral obligation about having taken out a loan. They have outsourced their morality entirely with regard to this transaction. The mortgage to them was nothing more than an anonymous financial transaction, much more akin to buying a forward contract than to an old-style unsecured bank loan. It was completely amoral.
I’m not saying they’re wrong, either; the loan was in fact overtly secured, for example. And the loan was treated no differently from any other securitized transaction. In fact, the system has made all such transactions about as impersonal as possible.
One of the results of that relentless application of financiering and NPV-ing and converting to financial terms is that there’s nothing left of what used to be. JP Morgan was famously quoted as saying he’d lend millions on a man’s good word, but nothing for all the secured assets in Christendom. Look at popular culture until a few decades ago–what does the couple in San Mateo think when they watch It’s A Wonderful Life, replete with people hanging on like crazy to fulfill the moral, financial obligations to each other transacted through the S&L?
Many people used to feel what I call a moral obligation to pay back loans. It had very little to do with the law, it had everything to do with what one “ought” to do as a citizen, a religious person, a member of a community, whatever. It’s what you’re “supposed” to do.
The percentage of people who believe that is now falling rapidly.
Doug, the fact that the law is clear in all these matters has as much to do with morality as a fish has to do with a bicycle. The fact that you can recite all the law around mortgage obligations and never even notice the absence of a sense of personal obligation in connection with repaying loans is, well, actually, a little scary. The fact that the connection seems odd to you is prima facie evidence of how bad it’s gotten, it seems to me. Smart, educated people like yourself seem perfectly happy believing that debt, mortgages, loans, obligations have nothing to do with morality, but are covered completely and adequately by a system of laws.
Laws are made by people; they are frequently changed. Compliance with the law depends on social acceptance of those laws. Slavery was once legal. It was once illegal for women to vote. If you have laws and no social acceptance of them, the laws become worthless.
The entire country of Argentina defaulted on its international obligations a decade ago; what teeth did the laws have then? If the IMF et al insist on bondholders getting their pound of flesh from Greece, Ireland and Portugal, the very real risk is that those bondholders will get very little at all, because those countries will pull an Argentina. In fact, the best way to guarantee they do so is to keep pretending that laws have nothing to do with social fairness.
At the extremes, when laws become uncoupled from morality, you get close to social unrest. And all the recitations of what the law “is” then become irrelevant.
The law strays far from morality at its own risk. In this particular case, we’ve now got nearly 1/3 of the people who are underwater saying that they no longer accept the legitimacy of the laws governing their debt. That doesn’t mean they won’t repay it, though some clearly won’t; but it surely means we have a level of social unrest that is socially destructive.
And as John articulated, when things are that far out of whack, a massive sense of unfairness takes hold. And the result, eventually, is either the laws get changed or ignored. I don’t think people generally settle down and say, well, OK, I guess we just have to be screwed for a few decades. Case in point: Germany after the manifestly unfair Versailles Treaty ending WWI. More likely, things get changed.
Charlie,
There are probably a number of causes for this behavior but it is still wrong. Economics is based on morality and trust (or lack there of).
As a consumer watching large companies and executives getting bailed out and subsidized the consumer says. “hey they made a bad decision walked away and got rewarded with millions in pay and perhaps even a new job; why can’t I just walk away?”
So what to do? I believe we have to start treating corporations and those that run them like the citizens they want to be treated as. I mean if they enjoy the rights of citizenship should they not also enjoy the responsibilities? As one stark example, If you want to contribute money to campaigns like a citizen then when your firm contributes to negligent manslaughter you should pay the same penalties an individual would.
The consumers see corporations and executives getting away literally with murder on the evening news and they wonder why they can’t just walk away from a mortgage.
If we are all citizens of the society, rich and poor, corporations and main street business then we all have to play by the same rules in the same game.
Justin Fox, editorial director of the Harvard Business Review Group, asks a related and much more pressing question: What kind of country reneges on its contracts?
Charlie –
I’m not very comfortable with equating re-paying mortgage obligations with morality. A poor credit report is mark of poor morality?
I thought you were going to discuss the moral, ethical, and legal problems around the mortgage origination process. That’s where the problems lie. Lenders were entering into contractual debt obligations with people who did not have the financial aptitude or understanding you would expect with giving them hundreds of thousands of dollars.
Mortgages are very clear about what happens if you don’t re-pay. The lender can sue you for the cash and/or can take back the property. Some states have stepped in and prevent mortgage lenders from suing for the cash; They are limited in recourse to the property.
Default rates and repayment rates are well studied by those savvy investors in mortgage-backed securities.
Contracts and contract law, including mortgages, are designed to deal with what happens in the breach of a contract. On top of that, the right to file bankruptcy is part of the constitution. Debtors’ prison was hated by many of the Founding Fathers.
If you lost your job and can’t repay your mortgage, then walking away or declaring bankruptcy are supposed to be viable options.
There is a more interesting thread of discussion for those borrowers who still have the income to pay their mortgage, but are concerned that the debt balance is far in excess of the current value of the home. For them, they have a poor investment on their hands, having lost whatever equity they put down, plus they have to continue to pay the monthly payments.
A strategic default is bit more interesting to think about than someone who just can’t afford their mortgage.
I do think that repaying a mortgage, a credit card bill or a hospital bill is in fact a moral obligation. There was a time when business was done on a handshake. It wasn’t so long ago.
Part of the challenge, and it has been articulate far clearer by others, is that when we live governed by laws v. morality, we fall into the mindset of, “We didn’t break any laws.” Even though they may have used dishonest and shoddy practices that required a massive bailout or some other harm against the public or individuals.
Part of the challenge that we have today is our response to every event is to create a massive set of rules to govern the situation. Then a group of professionals will get paid to find work arounds for it that don’t break the law.
Ayn Rand once said that Capitalism is a moral system as much as it is an economic system. I would suggest that economics depend on morality and trust. Where it gets tricky is where we try to legislate morality and or coerce morality.
Not an easy solution. As our societies get larger and more diverse our sense of “common ground” shifts. That just means we have to keep active in the conversation.
Charlie –
I want make sure that we draw a line between breaking the law and defaulting under a contractual obligation. I have my opinions on the fraud and misdeeds that lead up to the real estate bubble and the subsequent crash in prices that have put us in a place where we are debating the morality of strategic defaults. I will leave it up to the prosecutors to start doling out criminal liability. (Personally, I think there was more incompetence and ignorance than criminal behavior at the top; And vice versa at the lower, loan origination level.)
A failure between private parties, with no fraud or misdeeds, is governed by the rule of law in this country. There is an obligation for the parties to live up to their contractual obligations. I consider it a moral obligation and think most people consider it a moral obligation.
If one party fails to live up to the obligations, the other party has certain, limited rights for recourse. It’s a fundamental component of our society that people can get a fresh start. We don’t have debtor’s prisons. I think that’s a good thing. The lender has a moral obligation to not overreact. We do not permit lenders to take a literal pound of flesh.
That ability to walk away from a mortgage is one that would prevent the social unrest you fear. It may cause more economic damage to the banks but I would not equate that with social unrest. In government seem to be forcing lenders to compromise on the debt obligations. The politicians are on the side of the borrowers. (Borrowers vote; corporations do not.)
I also think it’s important to draw a distinction between those who default because they cannot pay, an income default, and those who default because the asset has dramatically decreased in value, a strategic default. The story that you recall is a classic strategic default. They overpaid during the bubble, prices have collapsed and they are throwing good money after bad. To some extent, there is also an element of a strategic default in an income default. If the property were worth more than the mortgage balance they could simply sell the property, repay the debt and pocket a few dollars.
I agree that the securitization of our debts is probably moving our country’s moral compass when it comes to repaying our debt. Largely, we are borrowing from big faceless entities that are repackaging and distributing our obligations. That also means that we are faceless borrowers that are little more than a monthly check. Perhaps people do feel differently about repaying a faceless lender than they do about repaying an obligation to their neighbor.
I see it as a positive sign of morality that the couple in Charlie’s story was having trouble deciding to make a strategic default. The pure economic argument would make it very clear that they should walk away. I think it’s a bit of a unique economic situation where real estate prices have fallen so dramatically that borrowers would even contemplate a strategic default. It’s also a new situation where so much of that debt has been repackaged into a complex morass of securitization. Perhaps there is an opportunity to see what effect this has on the long term default rate of personal debt and home loans.
Charlie, please don’t think that I overlook the personal obligations. I’m buying a new house next week and using my local bank to finance the purchase. I bypassed potentially less expensive alternatives from faceless mortgage brokers because I wanted the local connection. I know that my failure to repay would result in a personal, moral loss every time I walk into that bank. That’s a bank where my kids come in with their savings book and put their tooth fairy money on the teller’s counter. Put me in the “It’s a Wonderful Life” category.
Doug,
Thanks for taking the time to amplify your views, I found it helpful. (And I’m happy that we’re on the same side of George Bailey’s tale).
We both agree that–to use your terms–“There is an obligation for the parties to live up to their contractual obligations. I consider it a moral obligation and think most people consider it a moral obligation.” Me too.
We also agree that it’s a good thing debtor’s prison is a thing of the past, although I suspect we might disagree about the de facto version of the same thing. I have seen poor people enslaved to barely-legal interest rates that bind them for years based on contracts that are flatly illegal in less laissez faire countries.
Your view is that the courts favor the borrowers: that’s true at the 5,00-foot “no debtors’ prison” view. But at the 50,000-foot view, there are a whole lot of permanently house-poor people barely scraping by; meanwhile, Angelo Mozilo and Dick Fuld and all those who sold no-doc mortgages and those who packaged them into tranches and bought and sold them and insured them with swaps–well, we also don’t have lenders’ prison. From my perspective, the law is far more lenient with them.
Just to be clear (I probably wasn’t in the original post) on the TV couple’s situation: they were NOT having a hard time deciding, at least not on moral grounds. That was a piece of cake for them, they had crossed that line a whole lot earlier–they were operating already from what you call the pure economic argument. What they were having a hard time with was the likely resultant reduction in their credit rating, which they considered unfair–after all, all that they had done was to default on a loan! Which, of course, I found ironic and sad.
We both see the moral connection resting in one’s general obligation to repay loans. And we both agree that reasonable societies allow for legal, and I think moral, ways out of untenable situations. My concern is that when you have so many exceptions to a moral rule, the moral rule begins to lose its legitimacy. And in our case, I point to the Mozilo’s et al who shamelessly pushed the law to the edge, knowing they were bankrupting not only people’s financial bank accounts, but our moral ones as well. When an entire industry made so many egregious loans, with virtual certainty they they wouldn’t be repaid, it gives new meaning to the term “moral hazard.”
May the angel Clarence be with you.