This might be an easy answer…but I will pose the question anyway. If you owe more on your home than it is worth and choose to walk away from the house are you A) violating Standards of Professional Conduct 1d (Misconduct) or are you B) simply making a good business decision.
I am guessing most initial responses are A, it’s unethical and Misconduct. However, some presented it to me (after doing this very thing himself) as sticking the bank with the problem they created in the first place. His premise was that a house is just like anything else is a business transaction and while the banks have been making money for years on origination fees and high interest rates this is just the downside of that business. So, he argued, why would we bail the banks out on a personal level when they should have forecast defaults into thier models?
Justification for an unethical act or a rational new way of treating the banks (business foe).
I think most responses are going to be B. The CFAi has no business interfering in your personal financial matters as long as what you are doing is legal and not related to either your job or clients. The individual you spoke to is 100% correct. The bank is not giving you a loan interest free out of charity. That interest rate reflects their expectation of risk in relation to your contract and they have taken a stake that is senior to yours. If you pay off your loan, but take a loss on your equity stake, they won’t give you a charity payment to share that loss with you. Your home is an investment, you are an equity investor. If value of the home combined with present costs of bankruptcy are less than the principal outstanding, why in the world would you continue to make payments to the bank? You’re just giving them free charity money. In what other investment do investors in various classes just give undeserved money to each other willy nilly? If you still feel bad, calculate the amount you saved after bankruptcy costs and give it to charity, at least then you’re not bailing some moron out of a crappy investment, that’s what taxes are for.
I appreciate the way you expressed that. You view it as a clear business transaction, not an obligation that would be a reflection on either integrity or ethics. In a business transaction, the bank has to assume a portion of the risk and thats why they charge higher interest rates. It’s not charity. What happens if we wake up tomorrow and everyone who is underwater in thier home decides to treat it as a business transaction? Lending standards have certainly tightened up already, good for the long run. But how devastaed would our system (where we all get our paycheck from … one way or another) be?
Well you have to measure how detrimental bankruptcy is to you. Obviously your credit will be garbage for years to come, and if you need to borrow, you would have to pony up a lot on interest. What is the inconvenience of that worth? housing looks crummy now, but if you find a nice place that’s not excessive and you can see yourself living there for a long time, now is actually a great time to buy. People are getting 4.5% fixed rates, some banks are waiving closing costs…
Same thing that happens if investors in any other market all decide to dump their positions at once. That doesn’t make it morally wrong. You’re basically asking homeowners to prop up the investment world so others can continue to make money. That’s unethical. If you’re buying investments in an environment that you believe is fundamentally unsound (ie housing market still has a long way to go) then you’re taking just as big of risks as the banks that made those loans to begin with.
Remind me to bookmark this thread so I can track people who think walking away from a mortgage is ethical and I will try to never allow any of my investments to get into their hands… This is situational ethics at the worst. You can argue whether it is a good business decision or not, but many good business decisions are not ethical in the least. The fault in most logic can be seen when taking the argument to the extreme. The argument here is “If you sign your name to a contract promising to honor that contract, you only have to honor the contract as long as it works in your favor.” You know, I think the US GDP is worth a lot less than our outstanding debt, so the ethical thing to do would be to stick it to China and default on all of our debt right? “Same thing that happens if investors in any other market all decide to dump their positions at once.” 100% false. Investors in the stock market eat 100% of their losses. They do not have the option of sticking it back to the company and walking away even. If you define a house as an investment, then home buyers are responsible for knowing the risks associated with an investment. Bailing out investment banks was wrong and so is walking away from your mortgage. Good investment decision? maybe. Bernie Madoff seemed to be making good investment decisions for a long time. But intentionally breaking a legal contract is definitely unethical.
There are so many inaccuracies here. I’ll try to do the best I can with this, but I don’t have all day. Here goes.
Really? You would invest in a manager that holds losses beyond the point of making good business sense? Look at the track records of Soros or Goldman in particular, but any other all star out there as well. They’ve all had no problem gutting a company or cutting a loss or screwing other investors to remain on top. And on top is where they’ve stayed. This is not a business for people who become married to their investments.
Here again you’ve repeatedly ignored the “COST OF BANKRUPTCY” we routinely referred to in our discussion. This applies to both actual costs and opportunity costs such as those that would result from a financial crash. Because our own retirement plans, financial systems and ability to conduct government operations all hinges on treasury holdings and future issuance, that would obviously not be the correct course of action. Not to mention you didn’t take the present value of US GDP, which is clearly much greater than the value of outstanding debt there buckwheat. But yes, if China in some hypothetical scenario held all of our debt and we were in a Greek like scenario (are the Greek’s unethical for imposing an investor haircut?) it would be not only foolish, but unethical for our government to impose undue pain and suffering on the US population (to whom they owe fiduciary responsibility) simply to transfer wealth over to China. Also, when you sign a contract, you are not promising to honor it at all costs as you seem to believe, you are promising to honor it within the bounds of existing regulation, including that which applies to bankruptcy. The investor knows this, which is why you are charged an interest rate (what the F*CK do you think you’re paying interest above the T-Bill rate for?)
Are you an idiot? In equity markets, investments stop at zero value. At that point all losses transfer to the debt holders who were dumb enough to make those loans. Do you know why equity value stops at zero in markets? Because equity investors aren’t dumb enough to continue making non-contractual charity payments to the bond holders. It happens every day. A large institutional equity investor does an analysis, they determine the value of the company is less than the value of it’s debt, and they file for bankruptcy and walk away. It’s how markets work. Except for stupid people, they go on forums and argue that based on their lack of any comprehension of what goes on around them homeowners should disadvantage their families to pay some moronic banker out of a bad investment even after they’ve seen their equity investment wiped out and taken their fair share of contractual losses. You’re basically saying, “Yes, you used all my equity as a shield for your investment, and now that that’s gone, I’m going to give you MORE money because I’m an idiot.” Jesus Christ man. Oh, and P.S. what Bernie Madoff did was STEALING and FALSE REPORTING as well as not maintaining his fiduciary responsiblity. It is also ILLEGAL whereas bankruptcy is…get this… LEGAL and CLEARLY DEFINED WITHIN THE CONTRACT. God, read a f*cking book.
The cost of bankruptcy is included in the interest rate that the banks receive. This is why they can borrow money at 0 and lend it to you at 4.5%. Saying that a homeowner shouldn’t default because of some moral obligation BS is equivalent to saying it’s not “fair” that banks charge such a large spread when loaning money. Bankruptcy not only creates a market in housing, it also keeps the bankers honest. Next time around bankers won’t be so willing to lend money to people with little to no income in a neighborhood filled with houses that increased in value be 50% over a 2 year period and is filled with other people with little to no income. When it makes sense financially to default then the free market dictates that it should be done. Where was the outrage when Blackrock defaulted on its loan for the Stuy Town (residential apts in NYC)?
I apologize, I am a little rusty on my quant knowledge. I forgot that the intelligence of an individual in a discussion is directly proportional to the amount of name calling and profanity they add. I can’t tell you how many arguments I have lost to my 5 year old nephew when I have not been prepared for the “doo doo head” insult…oh the painful memories… “But yes, if China in some hypothetical scenario …” It was 100% a hypothetical, but thanks for arguing against the specifics anyway. I admit my equity example was not entirely clear. “In equity markets, investments stop at zero value. At that point all losses transfer to the debt holders” this is actually reverse. Debt holders get paid first and then the residual loss gets taken by the equity holders. The point I meant to make was selling your equity at a loss is different because YOU take the investment loss, walking away from a mortgage is using your mortgage as an option on your home value, which is NOT the intention of a mortgage. “LEGAL and CLEARLY DEFINED WITHIN THE CONTRACT” – My point was what is legal and ethical are not always the same. I thought that was clear. “Walking away from a mortgage” I assumed to mean that you can afford the payments, but don’t want to pay because your underwater. The INTENT of bankruptcy is to put people/companies through orderly default when they can no longer pay back their obligation, not when they no longer want to. You may want to reread the ethics portion of the CFA. The section on trading comes to mind… “The intent of the action is critical to determining whether it is a violation…” Therefore; I stand by my case that it is in fact unethical to default on your mortgage solely because you are underwater…oh and…Doo Doo Head!
No crap, that’s what I said, but assuming it’s underwater, equity gets zero, so in my example, as I stated, first loss goes to equity, but at zero (ie mortgage underwater, or value of firm below that of debt) then all losses transfer to bondholders. Think about it…
Ok, here I can’t tell if you’re being an idiot, or if you’re really this dumb. If your mortgage is underwater, you have already taken the full loss and are now walking away rather than continuing to transfer further wealth to the debt holder. Paying off debt on a property underwater would be analogous to equity values going negative in markets, which they do not, because at that point equity holders walk away and losses transfer to bond holders. Again, think very hard about this, because you’re clearly not getting a simple concept.
Actually, bankruptcy is valued as an option in pricing debt, it’s clearly covered in the CFA text as well as many published papers by famous economists including Nobel Prize winners. Again, you simply don’t know what you’re talking about.
That is one case, the other is when the property plus bankruptcy costs is worth less than the debt. In this case, as in that of a firm, the firm would declare bankruptcy and walk away leaving residual losses to bondholders as covered above. As both myself and Briscoe stated, this is how debt is priced, this is how their investment is structured. This is how markets are meant to operate. If you don’t get this, then you don’t understand how interest rates are calculated, why your equity takes first loss, or how markets in general are structured. REITS do this every day. In summary, nice try, but you’re still stupid.
Commercial property owners walk away from underwater properties all the time. Banks literally receive keys to the property in the mail. It’s part of doing business and always has been. Why should residential real estate be any different? If you’re underwater with little hope of recovery it’s actually in everyone’s best interest to walk away…I’d argue even the bank’s. You don’t get a medal for overpaying.
So much vitriol BlackSwan…I assume you or someone close to you defaulted on a mortgage. That sucks, but I don’t mean for you to take it personally. " If your mortgage is underwater, you have already taken the full loss and are now walking away rather than continuing to transfer further wealth to the debt holder" What loss? Equity is NET of debt owed. Most people who default have little to no equity in their house anyway. Your direct loss is limited to the interest you paid on the debt you borrowed and whatever small amount of equity you had. You can’t have a loss when you have no equity to begin with! Is it ethical to stop paying your credit card bill? Because guess what. Every purchase you make with a credit card is “under water”! Ugh, I know that option theory is used to calculate the probability of bankruptcy. That has nothing to do with whether its ethical. Interest has nothing to do with whether it is ethical or not either. Yes banks charge higher interest if they think you are more likely to file for bankruptcy. That does not make walking away from a mortgage any more ethical than intentionally hitting a car that is running a red light to collect the insurance payment because the insurance company already charges you for this risk.
Possibly, although I still think rarely it would be better for the bank unless you mean as opposed to having to sue the borrower. I can possibly buy the argument that it may be better long term for the efficiency of the market and the long run costs are lower to all participants than the borrower paying it down. I can see that. But the fact the RE investors do it, in itself, is not a logical argument for it being ethical. But I would agree they are either both ethical or both not. Although your lack of personal insults and profanity makes me wonder if I should accept your logic…
bottomline is if walking away from a loan is unethical then selling mortgages at different rates based on credit history is unethical as well. business is uncertain you know?
Again, you consistently fail to grasp the concept of cost of bankruptcy in your overly simplified examples such as this credit card one. Although, that would be one of the many reasons there are high rates on credit cards, because the user has no stake other than bankruptcy costs. Beyond that, most homeowners did at one point have quite a bit of equity in their homes. You’re making up assumptions now. And in the cases with little equity, the banks gambled, charged a higher interest rate (which they would not have refunded if you paid off your home), and lost. Now they accept their end of the bargain. It’s business.
Yes it does, that factor goes into setting your interest rate, which is how the bank makes money in this business. I don’t know what part of this being an investment you don’t understand
Interest has everything to do with the ethicality of it. Once profit and bottom line enters into the calculation it has become a business investment. The bigger issues is this, this is all I want you to focus on: If equity holders in public companies don’t have equity stakes that can go negative, and thus don’t continue to transfer money to bondholders when the company’s NPV goes negative, why should it be any different in a home investment. Or why should home owners be treated any differently when they participate in the exact same investment process as institution owned reit’s that default the minute an equity stake goes negative? The fact is the whole industry is built on these assumptions that go into pricing your interest. If you can’t address that, don’t bother responding.
I don’t agree with this whole notion that default rates are built into mortgage rates and thus defaulting on your mortgage is ethical. I especially don’t like it if we add the notion that it is in the borrowers best interests to default on the mortgage when the home is underwater because further payment is just enriching the bank. First off, if you walk away from your mortgage when the home is underwater the bank has every right to pursue you for the shortfall. The note doesn’t say that the bank is owed either $X or the value of the home whichever is less. It says you owe them $X and if the bank thinks that it is in their best interests they can pursue you and get a judgment for the shortfall. The collections on that kind of unsecured debt is really bad so banks don’t often do it. Anyway, I don’t have a really clear idea of the distinctions between legal and ethical but a judge can certainly tell you that you need to compensate the bank for doing that, so that goes a long way toward saying that it isn’t proper. Second the rates on mortgages aren’t really set based on any very good idea about default rates and recoveries. They are set by buyers of mortgage-backed securities who pretty much set the funding costs for mortgages. As the sub-prime crisis made pretty clear - these rates can be really wrong. Do the sources of mortgage funding deserve to be hammered because they mispriced the risk? Even if they do deserve it, do the agencies that backstop the debt and thus the taxpayers deserve to get hammered for mispricing it? From my point of view, the four C’s of credit begin with character and good character says that you honor your obligations because it’s the right thing to do even if it’s not in your own best interest to do it. Obviously, there comes a point where you simply can’t pay your mortgage and you must default on it. That’s no longer a character issue but one of those other C’s (capacity, I guess). As far as the original question - it’s none of CFAI’s business if you default on your mortgage. Ethics is a pretty slippery concept and CFAI has no real credential to intervene in your (legal) personal business relationships with your bank.
Strange thread. Aren’t you boardmembers supposed to also be some sort of forum moderators here on AF? If so I think you need to delete a few of your own posts Black Swan. Both you and burk85 need to have a beer together and talk about something less touchy, like abortion or politics.
Ok, I probably shouldn’t have called him stupid or an idiot. (brought on by the initial accusation that those of us saying it is ok are unethical). That being said, I don’t think being in a heated debate really qualifies for censorship or deletion if no one resorts to slurs, etc.
Not to highjack the thread, but many members of this forum are way too sensitive. We’re supposed to represent people that have dedicated a great deal of time to mastering financial concepts, but some conversations on here make the Yahoo Finance boards looks like lunch with Plato. I’m not commenting on anything specific to this thread, but there are several people on AF that are complete idiots. Civil debate is preferred when both sides have something constructive to say. However, if only one side is providing facts and interesting ideas, and the other is just spouting nonsense, call him out. Finance is a tough field. Grow some balls.