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Homeowners have even the Moral Right to walk away

Roger Lowenstein writes in the New York Times:

John Courson, president and C.E.O. of the Mortgage Bankers Association, recently told The Wall Street Journal that homeowners who default on their mortgages should think about the “message” they will send to “their family and their kids and their friends.” Courson was implying that homeowners — record numbers of whom continue to default — have a responsibility to make good. He wasn’t referring to the people who have no choice, who can’t afford their payments. He was speaking about the rising number of folks who are voluntarily choosing not to pay.

Such voluntary defaults are a new phenomenon. Time was, Americans would do anything to pay their mortgage — forgo a new car or a vacation, even put a younger family member to work. But the housing collapse left 10.7 million families owing more than their homes are worth. So some of them are making a calculated decision to hang onto their money and let their homes go. Is this irresponsible?

Businesses — in particular Wall Street banks — make such calculations routinely. Morgan Stanley recently decided to stop making payments on five San Francisco office buildings. A Morgan Stanley fund purchased the buildings at the height of the boom, and their value has plunged. Nobody has said Morgan Stanley is immoral — perhaps because no one assumed it was moral to begin with.

It’s fairly simple to the average calculating person – if the contract says it’s your house against the money, then you give back the money or give up your house, period. That’s that. The factors impacting your decision are irrelevant; that you can pay but choose not to, or that you can’t pay because you’re in deep doo-doo is a subjective call in the end. What might seem like miserable circumstances to me may seem perfectly okay to you.

To give you an example, it’s pretty obvious to the medical profession that we don’t need two kidneys. One is enough. But kidneys sell. So if a bank told you, “Listen, I know you have nothing but you can sell that extra kidney and pay us back” – Science and Medicine are likely to support them (provided they pay the costs of hospitalization, recovery etc.).

But is that sane? Not just you and I, but even banks will balk at making such requests. Only disgusting moneylenders who need removal of parts located slightly below their kidneys will think it’s fair. Ability-to-repay is going to be subjective, no matter what.

And that is not the problem. The real issue is that banks routinely flout the “spirit” of contracts, choosing to go by the letter instead, where they borrow. And they believe that is perfectly all right – in fact, they used it to explain that as the reason that AIG’s counterparties got paid in full, even though a more sane AIG could have attempted to renegotiate. Or in other banks’ (like Lehman or Bear) refusal to pay all debt back, by saying bankruptcy protects them.

To people in India, this argument is moot- all loans are with recourse to other assets, so if they can’t recover your money from your house they’ll ask you to sell your car or something of that sort , other than your spare kidney. But the law is very difficult to enforce, and litigation can take years. And without a personal bankruptcy law, it’s unlikely courts will side with the banks more than allowing them to take over the property. There is a more recent CIBIL credit rating which banks can use (and misuse) to ensure that in the future, getting loans will be difficult for a defaulter, and we will have to see the social impact of that. Yet, unless real estate prices completely crash, the system will not even be tested, and even then people do consider it a moral pain-in-the-neck to lose their house so it’s unlikely to be a pure business decision here.

(Footnote: I have loved reading Roger Lowenstein’s two books – Buffett and When Genius Failed )