Skiing in Los Angeles, by Steve Sailer
2 hours ago
Monday, December 21, 2009
Ruthless default
There has been some recent discussion about the morality of ruthless (or strategic) defaults in which a homeowner voluntarily defaults on a non-recourse mortgage loan (surrendering the property to the lender), although they are financially able to continue making the payments, because the property value has fallen far below the amount of the loan balance. A non-recourse loan is one in which the borrower has no further legal obligation after surrendering the collateral even if the value of the collateral is insufficient to cover the loan balance. This does not strike me as particularly wrong so I guess I come down on Salmon's side. However I think his justification that it is OK because banks are evil is wrong. The idea that it is OK to cheat evil people puts you on a very slippery slope. The way I see it you are just exercising one of your options under the contract. The same as if you refinance because interest rates have fallen, an option which is also unfavorable to the lender. The value of these options should be priced into the terms of the loan. Since you are paying for the option I don't see any problem with exercising it when advantageous.
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Putting an option into the loan agreement for a nonrecourse loan sounds a bit like mortgage insurance used when an owner who dies. The banker is in a bad way, as he cannot know if the property owner is going to die, default, whatever, in the thirty years of the loan. One would think the banks pay someone very well to assess those risks and then to increase the loan rates correspondingly.
ReplyDeleteThe mere fact that we pay the bank because we might default does not mean it is moral to default. Besides the portion of the interest rate that compensates the bank for potential default, another (smaller) portion compenstates the bank for the possibility that we are defrauding the bank. Does the fact that we must compensate the bank for potential fraud mean fraud is moral? There are many other cases where we pay for a potential service but where we would in many cases be acting immorally be enlisting that service (e.g. the police force).
ReplyDeleteI'm not saying defaulting is immoral, just that the fact that we pay for it has no bearing. It is up to us as a society to decide whether or not defaulting is immoral. Even if we were to go to the extreme and put defaulters in debtors prison, we'd still need borrowers to pay more than the risk-free rate.
I think the difference is default is legal while defrauding the bank is illegal. One way society expresses its collective decisions about what is moral and what isn't moral is by what it makes legal and illegal.
ReplyDeleteWhat does matter is the law. You may agonize over a moral imperative regarding a certain act, but the law is what counts. Making something moral and legal is the goal, but they don't always jive with each other.
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