Obviously this is Chad’s call about what is approriate and we should probably work out some guidelines. I though Black Swan was getting pretty close to the limits of civil conversation up there with some of his comments, but nothing really offended me all that much. I agree with the previous poster that finance is pretty cut-throat and you pretty much have to be able to take someone calling you an idiot from time to time. I call people idiots on other websites all the time…
Consider that you sign a mortgage contract that is exactly similar to the one you would sign today, but with an additional line that says something to the effect of “The borrower may discharge or reorganize this debt as prescribed by the rules of Private Market Bankruptcy and Foreclosure Code”. This means that implicit in the agreement of the contract is a method to walk away from or re-organize the debt under certain circumstances. So you would not be breaking any kind of contract. Now just remember that the Federal Bankruptcy code and a state’s foreclosure process is effectively implicit in every contract and there really is no difference. You might say that, oh well, if you walk away from a mortgage, then you’re “able” to pay, whereas in the other cases you’re not “able” to pay. Well that ONLY matters if ability to pay is part of the foreclosure/bankruptcy law or mortgage contract. To the extent that ability to pay is not included in the foreclosure law, it does not matter as to whether there is an ethical violation. Suffice it to say, if walking away from a mortgage is a violation of ethics, then any debt default is too. And so is bankruptcy.
That about sums it up.
“if walking away from a mortgage is a violation of ethics, then any debt default is too. And so is bankruptcy” is just not true. Walking away from a mortgage, debt default, and bankruptcy harm other people and that’s pretty much the basis for calling them unethical. However, in most ethical codes the prohibition against hurting others is not absolute. There are almost always reasons that you can harm other people ethically - to save another person from harm, to spare yourself from disproportionate harm, to punish someone for some other ethical transgression. There is this ethical code being put forth here that lenders voluntarily accept the risk of default and thus hurting them has no ethical consequences. I just do not think that is the contract between lenders and borrowers. It is also a rather cheesy way of getting around an ethical issue by saying that ethical rules simply dont apply to lenders because they have tacitly opted out of any status as victims. I think most people make loans with the idea that the borrower will endure some really significant pain to pay back the loan. However, at some point there have to be limits on the pain of the borrower as the ethical consequences of further harm to the borrower outweight the harm that would be caused to the lender. Nobody is expected to sell a kidney to make a mortgage payment. Good character says that a borrower should work as hard as he is reasonably able to do, forego expensive purchases, sell valuable assets, and similar to pay the mortgage. That means that every debt default can have a different ethical interpretation. Did the borrower take on enough pain to avoid causing harm to the lender? A person who just says that it is inconvenient for him to pay his credit card bill or home mortgage and he’s just not going to do it has some ethical problems - he has caused harm to another person simply because he didn’t want to inconveience himself. A person who has become completely disabled and thus is unable to pay the mortgage is an entirely different story - there is no ethical issue here because the person simply can’t avoid causing harm to the lender. In between, reasonable people can disagree about what is an ethical default and what is not. It’s just silly to group all defaults together and say that if one kind of default is unethical then all defaults are unethical.
Sure, perhaps deleting threads is a bit unneccesary, but name calling is pretty lowbrow. You can still have a robust discussion without calling someone else who disagrees with you ‘stupid’. Anyway, it was just a bit weird how it sort of flared up outta nothing. Enough from me.
I personally was not offended, more frustrated someone was trying to draw me into an argument instead of a discussion. I will admit my opening opinion was sarcastic and strongly voiced, however I actually was just answering the question posed. If I personally think walking away from a mortgage is unethical, then ipso facto I would also have to hold that someone who disagrees is unethical. This should not have been a shocking revelation, nor should it have been taken personally. I will admit I misread BlackSwan’s banruptcy analogy and I see his point (I tend to speed read while at work). The wording threw me off because BlackSwan was referring to the distribution of loss in bankruptcy instead of value. Which I have never seen referred to that way. Loss is a “negative space” idea really, you can not attribute loss before knowing value. So you can not practically “take equity loss to 0, and then start attributing loss to debt holders.” You start attributing value by seniority starting with debt holders until there is none left. I still don’t think it holds as a good example. The functions of debt and equity are different, unless you combine them to produce leverage which you do when you purchase a house. The only way the analogy works I believe is if it is a privately held company so the debtors and equity holders are the same entity. In this case if the company (equity owner) owns a building purchased with debt that drops significantly in value, absolutely the bank will not only take the building if they default but also require them to pay the full amount of the loan by liquidating company equity. The company will be on the hook for the shortfall in collateral, not the lender. (Obviously many residential loans are non-recourse so this won’t happen. Which is another reason why the comparison does not work.) This goes to my original point of why selling your (unleveraged) equity is not the same as walking away from a mortgage. So walking away from a mortgage is much more like refusing to post collateral when your margin account moves in the wrong direction.
I would echo that I agree its not a CFAI ethical violation as defined by the code, but I agree with JoeyD. In general ethics is about intent not civil or criminal law and the same action can be both ethical and unethical in different situations. I have the legal right to shoot someone in my house, it could be argued whether its ethical for me to shoot him in the back as he tries to flee. Same action response as if he entered my bedroom with a knife as defined by the “make my day” law, but different ethical implications.
I can’t stand philosophical conversations. It’s no more unethical to walk away from a mortgage than it is for an NFL team to cut a player that’s under contract. But, if you’d like to devolve into a philosophical rub-and-tug, let’s start the old fashioned way. Define ethics. Never mind. I got bored just writing that.
That one doesn’t really work that well because NFL contracts aren’t guaranteed and everybody knows it going into it.
I don’t see any problem with it. The penalties to your credit for walking away are pretty severe, so the home value has to be really underwater for it to make sense. If the bank is worried about people walking away, then maybe they should be more careful with their lending.
I believe that walking away from the house is unethical even though it is a wise financial decision. If you borrow money from a bank and promise to repay that money, why should the promise be conditional on the value of the house?
I guess we’re viewing the contract differently here, and maybe it’s because they’re written differently, or one of us is misunderstanding the text, or perhaps it’s just interpretation. I think it comes down to the basic interpretation of the contract. To me it’s an investment, but as I’ll make a case later, it depends on the class of contract. With no personal assets pledged, the bank is investing a debt stake in the collateral, under the assumption that an adequate equity cushion exists, you will make payments due to the high cost of bankruptcy and the benefit of rising home prices. The primary investment here for the lenders in my mind is the home w/ equity tranche protection. To me, the interpretation of the contract primarily depends on whether the loan is secured by personal assets or simply by the home itself. Case 1 (Personal Assets Pledged): I think that if it is secured by all personal assets, then it is something of a promissory note, where you have pledged to pay at all costs (this to me would be somewhat like breaking a promise to the bank and somewhat unethical). In this situation, whether you walk away or not is somewhat irrelevant as they will successfully come after you in court, so your best interest is in most cases to continue paying. Case 2 (Personal Assets Not Pledged): If the loan is not secured by all personal assets, but merely by the home, then I would view it more so as a mutual investment. In these loans, equity stakes are generally significant (if they are not, the bank is being reckless and intentionally gambling, so they get what they deserve, I would refuse to bail them out of their irresponsibility, any more than they would bail me out of mine). In the case where the equity stake is significant (and viewed as a mutual investment due to no pledging of personal assets), I would take a traditional capital structure view. Interest as cost paid to lenders, capital appreciation as unrealized earnings. First loss goes to the equity tranche, at which point losses are absorbed by debt holders. I would refuse to take further losses (taking into account the significant cost of bankruptcy) as this would simply amount to an unwarranted transfer of personal assets over to lenders (where personal assets were left out of the contract, typically at the cost of a higher rate as the bank is acknowledging the altered situation and increased likelihood and cost to lender of walking away due to lowered pledged assets). If the home experiences a small loss and wipes out half of my equity stake, the bank is not going to pay me for my loss, just as I would not pay them for their share of the loss (this all applies strictly to Case 2 with no claim to personal assets). For the sake of being complete there is a case 2 scenario where equity stake would be insignificant, where someone was a really really good credit (imagine a billionaire buying a cottage somewhere). But in this case the concept of walking away from the investment and accepting the massive cost of bankruptcy against the diminutive value of the home makes the concept of “walking away” implausible. For me personally… I’ve never had a mortgage, never had a family, although I assume the two would go hand in hand… I would only sign a mortgage as defined in Case 2 (to protect my family). And in the case where the property was majorly underwater, far beyond the costs of bankruptcy I would have to choose the ability to send my kids to college and provide a future for my family over covering the bank’s loss. My promise to my family preempts any contract to the bank.
The “promise” isn’t that simple. I promised to make the payments AND if I don’t, I agree that the bank gets my house. If the bank agreed to it when the lent me the money and I agreed when I took it, where is the ethical violation? As others have posted, if the asset wasn’t a house but instead a bond with an option, or a swap, or …, and it was exercised (by definition at one party’s disadvantage to the other’s advantage) is there an ethical issue?
Good point.
This is exactly what we are now seeing the banks doing. To qualify for the advertised rates, which are at unbelievable lows, you must have a credit score 720+ and a 20% downpayment. Otherwise, the rates that you end up paying are much, much higher. Unfortunately for the real estate market, there’s a small segment of the population with good credit, and an even smaller group that also has the necessary upfront funds.
“There is this ethical code being put forth here that lenders voluntarily accept the risk of default and thus hurting them has no ethical consequences. I just do not think that is the contract between lenders and borrowers. It is also a rather cheesy way of getting around an ethical issue by saying that ethical rules simply dont apply to lenders because they have tacitly opted out of any status as victims.” I like this argument - just because lenders priced in the risk doesn’t make it okay. Otherwise one could use similar logic as that presented in this thread to argue that arson is okay as long as the owner of the building has insurance. After all they bought the insurance knowing that someone setting their house on fire was a possibility. (note: quote is from JoeyD - the site was apparently undergoing some maintenance or something and the “quote” box was gone.)
Let’s restrict ourselves to the walking away from a mortgage point. If you live in a society where borrowers have been basically given an option to default, then any person lending money to them knows this going into it. It’s not like the rules are changed for them. It is fully consistent with any agreements they make. I would further argue that you’re not being dishonest by walking away when the government gives you the right to and the lender knows about the right before lending since your interest rate will reflect that risk.
I would distinguish between two kinds of ethics: the ethics of justice and the ethics of morality. The ethics of justice answers the question of what behaviors can society punish and the ethics of morality answers what behaviors should one take. I am primarily concerned with the ethics of justice. Can society punish someone for taking advantage of a default option on their debt? I would say no and I would guess you would too. I feel like you are more concerned with the ethics of morality, e.g. should someone use a default option when they don’t “need” to. To the extent that you’re not hurting anyone (see my point about ethics of justice above) and you’re not being dishonest (because they know you can do this), I’m not sure good argument there is against it.
Per Monger’s post referencing: “There is this ethical code being put forth here that lenders voluntarily accept the risk of default and thus hurting them has no ethical consequences. I just do not think that is the contract between lenders and borrowers. It is also a rather cheesy way of getting around an ethical issue by saying that ethical rules simply dont apply to lenders because they have tacitly opted out of any status as victims.” ^ I disagree with Joey’s quote here. Using the arson analogy is flawed because 1) The arsonist is not paying the insurance so they’re hurting both the homeowner (loss of possessions, risk to innocent life - wrong in all ethical codes) and the insurance company despite having no role in the contract. Secondly, if the arsonist was paying the insurance (it were your own home) it would be clearly stated in the contract that lighting your house on fire is not covered (lying about setting your own house on fire is also insurance fraud). So it’s a very inaccurate analogy. It would be like some outside individual illegally conducting actions to force you into bankruptcy on your house, which no one is defending here. In conclusion, I still believe pricing in the risk AS DEFINED BY THE CONTRACT (emphasis because bankruptcy is defined in the contract) basically, means the homeowner is paying the bank for the bankruptcy option - plus bankruptcy costs - (bankruptcy is valued as a debtor option in many cases - at least on theoretical grounds) should events go against them. This is in my mind part of how capital structures work. Now returning to the concept of “bankruptcy as defined by the contract”. If you’ve pledged personal assets (and thus future earnings streams) against the house (Case 1 contract as defined in my last post), then declaring bankruptcy while you can still pay is not within the defined terms of bankruptcy and you will be forced to rectify in court. I believe this would also then be unethical. But in the instance of a Case 2 contract, then I believe you’re still within the bounds of proper conduct.
I don’t see why everyone has to make this so complicated. Take this scenario: I borrow $15 from a friend to buy a Nickelback CD, only to discover that the music is essentially unlistenable. Do I have to pay the friend back, even though I now am “underwater,” i.e. I owe a debt of $15 for which I bought something worth far less than $15? It’s obviously in my best interest not to pay him back. It’s fully legal not to pay him back. I could blame the friend - he should have informed me that Nickelback sucked before I borrowed the money.
I’m not arguing the specifics of the contracts or stakeholders, only the justification that because one party acknowledges risk of the other party engaging in a certain activity implies it is okay for the other party to engage in that activity.