In this scenario they didn’t charge you interest which makes it NOT an investment and thus inapplicable, per all of our prior points. Please stop using wildly inaccurate analogies in place of logic and reasoning, it’s frustrating. But, sure, I’ll play ball to show a logical framework can even apply to this outside situation (economics is great that way). Once again I’ll re-introduce bankruptcy costs (both implicit and explicit) into the conversation because once again it’s been ignored. If your friendship is worth so little to you that you’d trade it as an implicit bankruptcy cost to save $15 bucks, then by all means, go ahead. The fact of the matter is anyone doing this would be doing their “friend” a great favor. And you’re right, part of the mistake is on the friend’s side for not heeding the warning signs 1) still buying CDs 2) listening to Nickleback 3) financially irresponsible to the point of needing to borrow $15 for CDs
Yes, why worry about inconvenient things like “specifics” and “facts” or even “reality” when you can dumb it down and make the dialogue sound like a presidential primary. Since apparently the validity of the analogy is irrelevant, “I guess I’d have to answer your question with another question…How many Abodiginals do you see modeling?”
Definitely a “subprime” borrower.
Black Swan, consider him as lending at 0% interest. What really matters is the default option relating to bankruptcy.
I don’t believe it’s the same actually. 0% is not market rate on an unsecured loan to a mediocre credit. Nobody’s paying interest reflecting compensation for risk. This is a favor from a friend rather than a legal contract in which someone is being charged for a service within defined bounds and obligations, it definitely falls under different rules than the investment world. In the markets, no body’s your friend. The IRS feels the same way. If you don’t charge at least a specified minimum rate it’s considered a gift, this typically comes into play between friends and family members. That’s the reality of the situation.
The Bernake disagrees with you. “The Fed - Handing out free money since 2008!”
It all sounds really funny when you say it like this “wall street can do whatever they want, lie, cheat, steal; but you the consumer should work till you die to make the bank profits…despite them recklessly blowing the value of your asset.”. Yeah sign me up for some of that man!
What’s this “default option” being suggested here? This is a finance-geek rhetorical trick to say that defaulting on a mortgage is simply exercising an option and has the same ethical standing as exercising your put. First off, if you read a mortgage document all the “default options” accrue to the lender. The lender has the option to declare a default (and thus demand payment and/or begin foreclosure) if the borrower violates the terms of the mortgage document which include timely payment, maintenance of the property, paying taxes and insurance and some other conditions. On any debt instrument default has to be an option to the borrower simply because stuff happens that means he might not be able to pay at all or without undue harm. We wisely rejected the notion of debtor’s prisons years ago. The whole ethical debate in my mind is what constitutes undue harm. Black Swan seems to have modified his argument so that the ethics of walking away from the mortgage depend on whether his personal assets secure his mortgage. I’m not sure that I understand that exactly, but that means the ethics of walking away from a mortgage depend on what state you live in. There are about 10 “non-recourse” states where the lender can’t come after you (including I am happy to say, my state Connecticut). There are another 10 or so “one-action” states where the lender can choose between suing you or foreclosing on you. Now I’m just a poor country lawyer, but it seems to me that the ethics of any action should not depend on geography. To pre-empt Black Swan’s likely response - I don’t know if mortgages are systematically priced differently according to recourse laws in the state, but I don’t think that the ethics of a default are determined by the interest rate on the loan. In the end, I think a mortgage note is a promise to pay. That means that not honoring the note is immediately an ethical issue - you broke a promise and caused someone else harm. But ethical issues always climb into lifeboats where the options are restricted. If the person can’t pay, then default is not unethical. If the person can pay but instead chooses a strategic default, then IMHO the person has failed to honor a commitment and is behaving unethically. There have also been a few attempts to suggest that the ethics of defaulting on a home mortgage are the same as the ethics of defaulting on corporate debt. The biggest problem with this is that the borrower in this case is a corporation and while we ascribe some legal status to a corporation we don’t usually hold it to the same ethical standards as a person. Employees at corporations can behave ethically or not, but the corporation itself is souless, deaf, and doesn’t care at all if we think it is behaving unethically. If you are lending money to a corporation there are only three C’s because “character” is just not an attribute you can ascribe to the corporation. That removes most of the ethical issues from corporate default.
That is the best summary of the argument I’ve read yet. Kudos sir. You may not be in volation of any CFA standards but there are many unethical things that aren’t covered. People who voluntarily stick others with their responsibilities are dirtbags. Pretty cut and dry.
I don’t see this as a problem.
Ok, Joey, first you said the clear cut situation is that by not fulfilling you promissory note to a bank, you are harming another person for your own benefit. But then later in the argument you go on to state that corporations (which consist of an aggregation of people) are not people and thus can’t be assumed to behave with character. Pick one. So basically, if you’ve incorporated yourself, you can screw over your counter parties left and right (which is what happens daily), but if you’re an actual person you’re accountable to work like a slave to ensure the corporations remain profitable and you fulfill your promise to the corporations. You may believe ethics aren’t determined by what state you live in, but I don’t believe they’re determined by what legal entity you’ve assumed either. Furthermore, you’ve oversimplified my case, I don’t believe the situation is determined by what state you live in, I believe the situation is determined by what contract you signed (in your terms, what was actually “promised”). And yes, there are systematic pricing differences to reflect the terms of various recourse classes of contracts, indicating the bank is on the same page on this as well. You can still negotiate a non-recourse contract in any state as a matter of fact as well. If this fails, throw you house in trust or corp for ~$2,000 in legal fees and BAM! Non-recourse. So assuming I’ve done that and the corporation I own has now signed a mortgage on this house, have the ethics changed? Or does the legal structure and the nature of the contract mean nothing? If the answer, and in my mind the obvious answer is “yes, it depends on the legal structure”, then we’ve essentially admitted to reducing the mortgage to what it is: a legalistic investment within the realm of markets rather than some grand covenant with Wells Fargo, God of Money.
Agreed, so we should change the legal system. All equity holders (including publicly traded) should be liable for all personal assets until they can no longer pay on any and all equity investments they’ve made, regardless of what capital structure or contract is in place.
Acting in a way that does not violate your legal rights is not the same as acting in a way that is ethical. For instance, it’s legal for Floridian pastors to hold Quran burning parties. However, this doesn’t mean it’s not a dick move. “Ethics” are subjective; Quran burning sessions are unethical only because people widely believe that they are unethical. Similarly, home default is legal, but this does not prevent many people from regarding such action as unethical. Also, since “ethical” is subjective, one person could define an action as ethical, while another person might define that same action as unethical. Neither is wrong, unless they are discussing the ethics in the context of some clearly defined guidelines, like CFAI standards.
In my opinion mortgage is a collaterized loan. I am hearing that it’s ok to walk away from paying off the loan because it was the bank’s decision not to ask for more collateral. Does that make it ethical to walk away?
I think that’s a fair interpretation of what I’m saying (in non-recourse cases). Continuing to pay when it’s underwater would be transferring personal assets into a contract in which they were never promised to pay off the bank’s fair portion of the loss as an investor on their debt tranche. Just as I don’t think it’s unethical to accept your loss on public equity and walk away in a bankruptcy (assuming equity to zero) without feeling the need to transfer money from your personal assets to the firm to bail out the bondholders. Both parties decided to invest, it didn’t work out, now there’s losses. That’s just the way I see it.
First off, I don’t have to “pick one”. I expect people to behave ethically in part because I expect people to behave in the ways that I behave. In fact, most of my ethical judgments are based on the conduct that I have been taught is appropriate for me. I am not a corporation and I have much different ethical expectations from an entity that has perfect diffusion of responsibility. Corporations need to adhere to laws and any insistence that they behave in some other way is likely to be met with a shrug and a “I don’t make the rules”. That’s the most I expect from corporations and the most I recommend anybody expect. Note that residential and commercial lending are usually separate in banks and part of that is expectations. Second, the “contract” that you signed when you get a mortgage is broader than just a few documents. The contract between you and the bank consists of the document and all the laws pertaining to home mortgages in your state. So if you believe that the ethics are determined by the contract, you believe that the ethics are determined by the state you live in. Throw the house in a corporation and go to the bank and attempt to borrow money in a recourse state and you aare dealing with an entirely different area of the bank and an entiirely different set of qualifications. If JoeyDVivre wants to get a mortgage, I go to residential lending, tell them about my income, my credit score, the assets that I will use for equity. If JoeyDVivre, Inc goes to a bank for a mortgage, I will go to commercial lending. There will be one of two discussions, either a) will I sign a document allowing recourse and then we go back to previous situation or b) what are the cash flows to the company likely to be and do they justify the risks in investing. The ethical situation there can be completely different - in one case, I am signing a document that entails personal accountability and in the other I am signing a document as an officer in a corporate entity that specifically denies personal accountability. Hence the answer to the question a “So assuming I’ve done that and the corporation I own has now signed a mortgage on this house, have the ethics changed?” is surely yes. The expectations of the lender have changed and your position in the loan has changed. I’ve signed leases (never mortgages) in the names of LLC’s I’ve controlled and I was pretty much upfront with people that if my business failed, I would default on the lease without regard to my personal assets. That’s what LLC’s are about. If they didn’t like that, then they shouldn’t rent to me. I would have felt fine about walking away from those leases. Ethical behavior can sometimes be about expectations of proper conduct. " Or does the legal structure and the nature of the contract mean nothing? " is complete the opposite of my point. " grand covenant with Wells Fargo, God of Money." is silly rhetorical flourish. I have never suggested anything like this. I believe a mortgage and a note with Wells Fargo gives me some level of ethical obligation to Wells Fargo (I had a mortgage with Wells Fargo once in fact that I dutifully paid off). I neevr once thought of Wells Fargo as “God of Money” or that my note rose to the level of covenant. For example, if I had become disabled, I would have remorsefully told Wells Fargo that I couldn’t pay the note. BTW - It seems to me that one way of looking at this is that ethical conduct is about a social contract that keeps costs down for everyone. A decent ethical system is to say that our only ethical principle is to adhere to laws and if we can screw someone over within the laws, there is no ethical issue. I hate this ethical system, in part because it creates this massive drag on everything we do in that we have to establish legal protections everywhere and understand our legal status in all our (risky) interactions. That means we become awash in lawyers and our conduct is constantly monitored. Obviously, our society has gone a long way down that path in my lifetime and it’s not a good path to be on.
Then I don’t understand where you’re saying we differ. On 12/5 (11:53 am post) I basically outlined all of this, even concluding that with regards to recourse loans “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)” and then going on to delineate that my argument would only apply to non-recourse mortgages. That’s the point I’ve since stuck to, because I realized that prior both sides had different contracts in mind. Your last two posts have been since then and somehow appear to be arguing against that position despite the fact that based on your last post you seem to be agreeing with me? I’m interpreting what you’ve just said as clearly stating that the contract itself and the expectations are relevant and a non-recourse loan would in essence be subject to a different set of expectations and ethics. I’m missing what you’re debating in your two posts since. Particularly since the paragraphs I’ve quoted seem to conclude the contract is relevant, that yes, this changes the ethics as they are dependent upon expectations, and that apparently the logical conclusion would be that then you’re inferring yes, the state does in fact impact the ethics (assuming you can’t structure non-recourse in recourse states). We disagree on the ease and process behind a non-recourse loan, I worked credit in Business Banking at God of Money in a non-recourse state (not Commercial Credit) and I’ve personally seen many loans structured this way with loans collateralized by properties in a corp with no real cash flow, but simply the understanding that we were protected by the equity stake. But fine, this is a detail. I also strongly disagree that dispersion of responsibility nullifies the accountability of corporations, nations, religions, or any group for that matter. For whatever reason, it appears, we have differing views on that, but my personal angle is that large groups should be held to the same standards as individuals, no less. But that’s tangential.
I think everyone would agree that the guy who loses his job or is injured and for whatever legitimate reason is unable to make a mtge payment without being unduly burdened is a legitimate candidate for a loan default (no ethics question there). Where there is dispute is a scenario where a guy bought a house for 700k on an IO loan when he was making 100k/year. Fast forward 2 years and the house is now worth 400k and his payments have increased by 30% because of a rate reset and his salary has remained the same – his monthly payment now represent 60% of his take home, rather than 40%. The guy goes to his bank and asks if he can renegotiate the deal and basically have the bank eat half of the 300k equity loss. The bank says no. What to do? We all know that the person who took the loan in the first was stupid, but does the bank that made the loan shoulder any of the blame? Should the person really continue to pay for housing which is likely twice the rate he could get in rental market? Or, someone buys a second home in Arizona for 700k with 20% down and that house drops 50% in value. The owner has $2 million sitting in his account. He’s 65 years old and could care less about the house or his credit score. Take the loss or bite the bullet and pay? For me, I personally hate to think that non-measurable issues like personal character weigh into decisions such as strategic defaults (although, after reading the thread my moral compass has slightly drifted over to the lender side of equation). I like the think that ethics are taken out of the equation and loans are made, and paid, on the basis of an analysis all available/potential outcomes (if that were the case why would a loan even be issued in the second scenario?). Lenders should anticipate the possibility of potential defaults (strategic or otherwise) and they should price these accordingly into the interest rate.
I think reasonable people can disagree about this one and for the most part I have been defending lenders. However, in a case like this I wouldn’t have that much trouble with a default. The bank made a $600K loan to a guy earning $100K (he had to put in some equity right?)? The bank lenders are supposed to be financial professionals and have some responsibility to make sensible loans. They are supposed to be smarter than the guy taking out the loan. A 6:1 ratio is just not responsible and the bank needs to eat this one. Of course, since the debacle in 2008-2009, there just aren’t new loans with ratios like this being made anywhere in any significant numbers. The cases where I actually see the most unethical behavior isn’t firsts, it’s HELOCs and reverse mortgages. If a person has a first mortgage with Wells Fargo and a HELOC with First Anytown Bank, they can basically tell First Anytown Bank to go leap and First Anytown can’t do too much about it. They can’t foreclose without buying the first and most banks don’t want to go buy more debt from someone who has just defaulted on a significant amount of debt. Foreclosure takes three years and can be delayed even more with bankruptcy and holding two non-performing loans from someone for 3-5 years instead of one can make the bank look silly. People know this and default on HELOCs just because they can. I think this is very poor behavior. Reverse mortgages are even worse. Somehow the old folks have learned that they can take out a reverse mortgage and stop paying their property taxes. The law says that the bank is not allowed to escrow taxes and not allowed to ding your credit line for the taxes. That means that to protect their position, the bank has to pay the taxes and they can’t do a thing about it. There are a bunch of old folks out there who think this is very clever and they are taking out reverse mortgages including the tax relief in their calculations. This really honks me off and is very unethical behavior in my book.
Bullet points guys, bullet points.