I read the following article tonight: Strategic Default or Efficient Breach? that speaks about the supposed "moral obligation" to continue making payments on an underwater mortgage. The article generally jives with my thought process, especially as it relates to non-recourse mortgages. Specifically: 1. "The risk that the lender would be left with the home instead of the stream of payments if the borrower defaulted, for any reason, is one that is allocated to the lender under such a contract and 2. "...and is presumably reflected in the price (i.e., the interest rate and other costs) that the lender charged for the loan." and 3. "The lender loses nothing when it gets exactly what it bargained to receive in relation to a risk that it was paid to voluntarily assume." and 4. "After all, a dealâ€™s a deal." How is this unsound logic? I know many (most?) think that defaulting on a loan where the terms are clearly spelled out is somehow immoral. Many institutional borrowers are currently doing this without the same media attention and scrutiny. Can someone please explain how this is unethical to me? I realize that I will likely be in the minority and I am prepared to take a beating if need-be. Please keep the thread civil though. I would really like to try to understand this.

As much as I would like to blame the banks, government or others for the housing bubble, at some point I have to take responsibility for my own actions. It seems that society in general would rather play the blame game than to take ownership of there life and responsibility for their decisions. The housing bubble has created a situation that has tried many families. Do I blame people for walking away? No. Do I think it is a good thing? No. Choosing to walk away from a loan is a personal situation and I'm not going to say it is wrong or right. What concerns me though is when we justify it afterwards with it was the bank's fault or the governments fault or someone elses fault. If your going to walk then at least take ownership of the decision. There is a price for walking for both the family and the rest of us. it also creates an opportunity for some while creating extra hurdles for others. I sure don't want to spend the energy calling it moral or immoral. It is what it is. Many have already walked. Probably many more will. In the meantime the lending industry will change and adjust to the new playing field.

If Joe and Jane default then that is not strategic that is lost of a job and unable to keep up with the mortgage payments and needing to move in order to live- You cant find a job for 2 yrs thats survival. If Joe and Jane bought the house and they are 200k underwater and Joe has had the same job for 14yrs and recieves constant raises and the only reason he is defaulting is because they no longer want to make payments on a house no longer worth that amount then that is strategic default. How is it the banks fault? Noone forced these people to buy a house for x amount at the peak of the bubble. They choose to do that because they felt the bubble had further up to go and they wouldnt be the one left holding the bag when the music stopped. They were wrong and they are left holding the bag unfortunately. That is life- They made a business decision so did the bank. If they had bought 5yrs before and values had gone up 100% and they were able to sell for 200k more than they bought would it still be the banks fault or it is only the banks fault when the people come out on the losing end? I bought several houses during the years and if I bought at a bad time I have noone to blame but myself. We cannot be a society who seeks to blame everyone for our own choices. Edit- I think the problem here is we are blaming the banks for this whole thing and that is only partly true- Everyone got greedy- The banks, the appraisers, the homeowners who saw others profiting and gaining massive net worth in real estate overnight, the hedgefunds who saw that they could use real estate to make profit for investors, the real estate agents who thought I can make more commission by selling a house for 500k than one for 180k. Everyone came togather and made a nice chunk of change except the person who chose to buy and now is underwater but they made the choice to buy.

Well, at the very least, we've found a topic about which people are passionate. For me, it all begins and ends with the word "strategic." That means that people are defaulting not because they have to, but because they want to. We're not talking about people who simply cannot pay. I have every sympathy for those people who are losing their homes because they've lost a job or endured some other awful event. Instead, though, we're talking about people who choose not to pay. Naturally if someone simply doesn't have the money, they default. Nothing "strategic" about that. Sure, the lender has collateral, and sure, the agreement is, "If you don't pay, we'll take the property back." And obviously when that agreement was written, the idea was that the property would be worth enough to cover the loan in the event it ever came that. So, did the lender take that risk? The risk that the property might lose value? Yes, of course. No one's arguing that. However, the lender's primary criteria for underwriting any traditional loan is not the collateral itself but rather the borrower's ability to service the debt. Not willingness to service the debt, mind you, but ability. And by definition, anyone who is contemplating a "strategic" default has the ability to pay. They just choose not to. Sort of a "Heads I win, Tails you lose" approach to borrowing. If real estate values held or went up, then the lender gets a small amount of interest. And if real estate values tank, well, too bad, so sad, you just take a 20% to 50% loss on your principal. Suckers. And to try to blame the lenders for putting people into products they should not have been in, well, that just falls on deaf ears to me, again, when we are talking about people contemplating "strategic" default. Again, they have the ability to pay, so it's not like they got into something they couldn't handle. They're just choosing not to do so. Somewhere along the line, someone made an analogy about breaking a cell phone contract and paying the termination fee. I don't think that's anywhere near an apples to apples here because, by design, that termination fee is meant to make the carrier whole. As we all know, that fee is meant to offset the money put out by the carrier to the hardware manufacturer to reduce or offset the cost of the phone. Now, if the mortgage note said, "Feel free to cancel this deal any time, just pay us the difference between what you owe us and what the house is worth, if it's worth less," you'd have something to compare. Again, I say that if you're OK with strategic default, then you should just get as much unsecured debt as possible and not make any payments. I mean, you have the ability to make the payments, but now you just choose not to do so.

I see no problem with people walking away if they so choose. There are consequences for walking away though. Not only for the homeowner or investor, but others. Lenders are going to be less willing to lend without in some way minimizing there risk. Personally that last thing I would want to do is walk away. Fortunately as well I understand what I'm investing in, so there is less risk of being underwater or stuck with negative cash flow.

Strategic Default or Efficient Breach?

Account Closed

Real Estate Investor · Chicago, IL · Member since 2009 · 178 posts · 62 votes

15y

The author also writes:

"But it is unclear to me why borrowers should bear any special moral burden to carry the cost of these sorts of systemic externalities. And it seems ironic to me that entities like Fannie Mae, which are as responsible as any for creating the systemic risks that the default wave poses to the larger economy, are often as not the ones pushing the â€œstrategic defaultâ€ moral narrative."

Morality is highly subjective and should not be a consideration. If a contract allows this type of an exit and a home owner has no choice than they should do whatever suits them best. Companies often breach contacts and often must pay penalties. Even real estate loans have "prepayment" penalties. Considering that this whole crisis is largely because of paper origination, sub prime mortgage sales and the MBS packages and other structured products, that the penalties have already been incurred on the homeowner. In this regard it wasn't really the homeowners fault for getting tricked by loan office, which led to our issues today. Loss of equity is huge for the home owner, though banks get bailed out by the government. I don't know of any individuals getting bailed out. I say screw the banks, give the homeowners a break they have been gouged enough.

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Eric M.

Flipper/Rehabber · Louisville, KY · Member since 2008 · 1k+ posts · 1k+ votes

15y

I too used to think it was somehow "unethical" to "not pay your obligations". But in the case of a mortgage, I was swayed by the argument that defaulting on a mortgage is not "breaking the contract".
A mortgage and note form a "complete" agreement. I agree to either do this or do that. I agree to either pay the note as agreed or I will give the property back. It doesn't say I guarantee to pay the full amount no matter what. It says I will do one or the other. And the borrower agrees to that deal.
So as long as you give the house back when you cannot pay, (imo deed in lieu is the most moral way to do this) there is no breaking of any contract or any moral obligation.

It is only when you take steps to hold continue living in the house longer than the normal FC process would take or you damage the house or you stop paying assessments or taxes or other things that any moral obligation is broken.
If you pocket rent while not paying your mortgage, I think that is wrong too.

However, I do think asking for a loan mod and even a short sale is morally suspect. That is breaking your original deal and attempting to put the burden of the market decline or your job loss on someone else. Of course, it is their choice to accept the mod, so if they do, then fine. But people somehow have gotten this idea that a mod should be granted easily and they are entitled to a mod (or short sale or any other type of debt forgiveness).

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Vikram C.

Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes

15y

Ethical issues are best evaluated in the context of the culture and the time. What was once considered moral may no longer be considered moral today. Similarly, what is considered moral in one country may not be moral in another.

Strategic defaults are something that would be considered unethical in most countries that I am familiar with, but seem to be standard practice here in the U.S. I guess that makes it morally acceptable here and unacceptable in those other countries.

I think this points to a bigger issue. When it comes to legal issues, I think the U.S. is at one extreme end of the moral spectrum. Anything that is permitted by the law or by a contract is considered morally acceptable here. I think that increases the costs to the economy of various types of transactions and makes it very important to have contracts drafted very comprehensively to account for every conceivable situation.

The net result is a highly legalistic society with a high cost of doing business. I am sure we will be better off as a country if we were a bit more old-fashioned with our values instead of being so legalistic.

In short, I think strategic defaults are not immoral given our current culture. But I would like to see our culture change to make it immoral.

2 Reply

Stephen McKee

Specialist · Riverside, CA · Member since 2008 · 382 posts · 72 votes

15y

I'll give the same answer I've given 100 friends. You and the lender signed a contract. The terms are spelled out. If you abide by that contract then "morals" have nothing to do with it. Notes basically say, "if you don't pay me I'll take the house back". Sense California is a single action state then there is no more recourse for a lender on purchase money after they foreclose. The questions become very archaic. Who's going to eat and the end of the month, you or your lender.

Strategic Default or Efficient Breach?

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