From an article in today’s NY Times about people who walk away from mortgages:
Walking away, he knows, is not without peril. At minimum, it would ruin his credit score. Mr. Koellmann would like to attend graduate school. If an admission dean sees a dismal credit record, would that count against him? How about a new employer?
Most of all, though, he struggles with the ethical question.
“I took a loan on an asset that I didn’t see was overvalued,” he said. “As much as I would like my bank to pay for that mistake, why should it?”
That is an attitude Wall Street would like to encourage. David Rosenberg, the chief economist of the investment firm Gluskin Sheff, wrote recently that borrowers were not victims. They “signed contracts, and as adults should also be held accountable,” he wrote.
Of course, this is not necessarily how Wall Street itself behaves, as demonstrated by the case of Stuyvesant Town and Peter Cooper Village. An investment group led by the real estate giant Tishman Speyer recently defaulted on $4.4 billion in debt that it had used to buy the two apartment developments in Manhattan, handing the properties back to the lenders.
Moreover, during the boom, it was the banks that helped drive prices to unrealistic levels by lowering credit standards and unleashing a wave of speculative housing demand.
There’s the old adage about business ethics being an oxymoron, and it certainly applies in this situation. Financial institutions themselves care only about making money. I know someone who recently left a job to take an allegedly better position with a bank. A month later, the bank decided to cancel the project they hired him for and let him go. Now he is unemployed. The bank could certainly afford to keep paying his salary, but the bank decided it had no legal obligation to do so and it was better to save money (thus creating more money with which to pay the bank bigwigs multi-million dollar bonuses) rather than live up to any non-legally enforceable promises made when he was hired.
If banks were stupid enough to lend money in a non-recourse mortgage state without requiring a sufficiently high down-payment, then it serves them right.
The last paragraph of the NY Times quote is especially poignant. Had the banks not irresponsibly lent money to homebuyers, then there wouldn’t have been a housing bubble in the first place, and there wouldn’t have been a subsequent sharp drop in prices causing those same borrowers to be underwater.
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Steve writes:
Any lawyer (or even first semester law student) could tell you that a contract is defined as "a promise to perform OR to breach and pay damages." There is nothing unethical about breaching a contract, especially a non-recourse mortgage. You walk away, the bank gets the house. Indeed, this is spelled out in the contract itself.
And it has nothing to do with the banks being wolves; it's simply that they took a risk of giving a loan to someone to buy a house and it didn't work out. Besides, the bank already assumes that a certain number of borrowers will default and figures in this information when determining interest rates (i.e. those with poor credit scores pay higher rates).
And after I attended a day-long bankruptcy CLE program, I learned that bankruptcy lawyers feel the same way about bankruptcy: it’s not a moral decision; it’s just something for which you should weigh the costs and benefits. One of the topics was how to advise the client for whom bankruptcy was in his best interest, but who didn’t want to proceed because of misplaced moral feelings.
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