What's morality got to do with it?

By February 16, 2010Foreclosure

Last week a group of investors, including California pension funds CalPERS and CalSTERS, a Florida pension fund, and the Government of Singapore Investment Corporation, walked away from more than a billion dollar investment and a $4.4B loan on Stuyvesant Town – a 56-building 11,000-unit apartment city in Manhattan, whose value had dropped by $3.5B to below $2B.

Despite the massive loss, it was clearly a sound financial decision by these investment professionals to protect the funds under their care from further losses – put plainly, they were smart not to throw good money after bad.

Yet many continue to labor under the idea that unlike these businesses, homeowners have a moral obligation to make payments on their mortgage even when it makes no financial sense to do so.

The case I hear most often is that the homeowner has a moral obligation to “honor the contract”. This seems to me to naively set aside the simple fact that there are two parties to a contract, and that as part of the agreement between those parties the lender signed up for the very real possibility that they might end up with the property if the homeowner became unable or unwilling to pay. If this was not simply an option for the homeowner, there would be no reason for the foreclosure process to begin with… instead we’d be building debtor’s prisons.

Others, often those in homes that are rapidly declining in value, believe that homeowners have a moral obligation to make their payments as doing otherwise harms society at large by causing property values to fall. This is a flawed argument on multiple levels:

  1. It assumes high property values are in societies best interest. That’s questionable for a variety of reasons, but clearly there is a stronger moral argument for affordability when it comes to home prices.
  2. It assumes foreclosures cause price declines. I’d argue the opposite – price declines cause foreclosures. And in this case price declines were inevitable since prices were artificially inflated through unsustainable lending practices. Seems to me the morally correct thing to do is unravel that mistake as quickly as possible.
  3. It assumes that in our consumer driven economy the greater good is better served by leaving more than 25 percent of homeowners underwater in their homes. Wouldn’t we be more likely to see economic recovery and job growth if our national mortgage debt once again represented a sustainable percentage of our national income and we returned to traditional levels of disposable income?

Setting aside morality, the decision to walk away from one’s home is still anything but easy. Most people have an emotional attachment to their home and the memories associated with it. Walking away also impacts the homeowner’s credit, the lender may have further recourse against the homeowner, and there can even be tax consequences.

Unfortunately in all the talk around the morality of foreclosure and walking away, we are losing sight of the bigger picture – finding the most effective way to return to a sustainable level of debt, a healthy housing market and a robust economy.

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  • Indy says:

    There’s not one answer to this ethical question. Not only do people have different moral values, but each individual situation is unique and requires its own moral analysis which takes into account all of the circumstances.

    That’s why contract law contains certain conditions that excuse breach or invite renegotiation under conditions of hardship, frustration of purpose, or a material change in circumstances or the reasonable expectations that were relied upon to enter into the relationship in the first place. The question is always “Who bears which risks when these events occur?”

    I think though, that if you ask people “If the debt contained a term that explicitly described and authorized a ‘walk-away’ process should home-values decline 20%+, would that be ok then?”, then most people would deem it a moral choice. People’s attitudes towards this seem to be determined by whether they understand mortgages to implicitly contain this provision by operation of law.

  • Robert says:

    Sean, I’m going to stick my neck out here are argue the case (in brief) that it _is_ morally wrong to walk away from your mortgage _just_ because it is financially convenient.
    So, break down the people of the problem into, say, three categories.

    1. People who should never have bought a house they couldn’t really afford – especially when the loan reset. Both they and the lender made judgement errors. (One could argue about the morality of the lenders, but that is not part of this discussion.) Let’s leave these people out.

    2. Then there is the person who could normally have afforded their property, but they have since lost a job, spouse, other and can no longer afford their loan. This is unfortunate and the language of the mortgage document clearly states how the two parties will handle such a situation. Let’s also leave these people out of the conversation – they are not part of the strategic default – walk away problem.

    3. Our third group are the people who have the ability to maintain their mortgage but chose to walk-away because they “want to”. These are the culprits for who we have people arguing for/against their morality.

    Let me start by acknowledging Indy’s remarks about contract law and how someone choses to interpret a contract. I’m no lawyer, but my understanding is that if it isn’t written, then it is really not part of the contract. So, “implicit” in a contract is a bad thing.

    My belief of why we have specific language in a contract is for one of two reasons. The first is to define the essence of the contract itself. The second are additional clauses that attempt to simplify resolution if/when the contract is breached. Hence, let’s assume the contract essentially states, “1. We will loan you $$ on the condition that you repay us at this %% rate. 2. Should you fail to pay , we will take posession of your house.”

    The essence of the contract is part #1. “We will loan you $$ on the condition that you repay us at this %% rate.” This is the contract to which you have agreed and have, as they say, a moral obligation to comply.

    Now, part #2 is an acknowledgement that sometimes people can’t pay, whether it is death, job loss, etc. This part codifies the consequences of a _breach of contract_ so that there is not huge hand-wringing or wrangling when such an eventuality occurs. No need to go through a long judicial process, no need to get 12 fellow debtors to determine what penalty you should pay, etc. We are going to make this clear, so that should we ever get to this point, we all know how to resolve the situation. Thus, we have easy resolution for people in categories #1 and #2 above.

    Per the above then, I claim the contract does not say, “Fulfill your obligation until you no longer feel like it and then we will accept the burden of the property.” I claim that it makes a clear obligation for the extension of credit and then declares how a _breach_ will be resolved.


    Let’s ask this a different way. “Is it fair for you to borrow money to buy a house AND a car with it, and when times get tough ONLY give back the house?”

    How many people went out and bought cars, jet skis, boats, vacations, etc., with their house? Now, they decide that it is convenient to walk away from the house, but they are going to keep all their toys.

    I loan you two dollars that you promise to pay back, but you buy an ice-cream with one and give me back the other and call it even. No, that is stealing.

    I think this is were more people are morally outraged.

    If these people gave back all their toys when they gave back the house, I don’t believe we would all be having the same discussions on the morality of the strategic default.

    • Sean O'Toole says:

      Great comment Robert, thanks for taking it on.

      You made a lot of points, but let me skip to what I took to be what you feel is the core of the moral outrage: “Is it fair for you to borrow money to buy a house AND a car with it, and when times get tough ONLY give back the house?”

      Let’s be clear that was the deal the borrower and lender entered into. The lender had the choice not to provide cash to the homeowner to do whatever they want with in exchange for nothing more than security in the house. That was the “basis of the bargain”. The lender could have also asked for a secured interest in the car, boat, or whatever, but the lender >chose< not to. And no government organization forced lenders to make cash-out refi's or HELOC's. As such I find this to be the weakest of all moral arguments. Put more plainly, lenders made stupid loans, and the natural, moral, consequence is for them to accept the losses. That said, I have actually proposed that in the event we do pursue a homeowner bailout of some sort, that those who got cash-out be treated differently - basically that the cash-out portion not be bailed out and instead be converted to an unsecured loan (which is really what it was in the first place). This would enable homeowners to sell if they needed to while still giving the lender the ability to pursue their loss. This market will be healthier when lenders have to live with losses from bad business decisions, as we'll be more likely to avoid credit induced bubbles in the future. It will also be healthier once we return to a more traditional percentage of income being spent on housing, as it will free the remaining income to start helping rebuild our economy. As such I think asking people to continue paying out of "moral obligation" will in the long run do more harm than good.

      • Robert says:


        There are two different issues under discussion here.

        — With respect to the “banks”
        1. Did the banks make stupid loans? Yes. I think we both agree on this point.
        2. Do they “deserve what they get”? Yes. I think they probably do. I believe you also agree with this point.
        3. Will the market be healthier when the lenders have dealt with their losses? Again, I think we are probably both on the same side of this view.

        — With respect to the borrowers.
        I am not arguing that there is a moral obligation to pay their loan _because_ the banks will hurt otherwise. Rather I believe in asking the question in the abstract.
        Do they have “moral obligation” to conform to their contract? This appears to be the only point where we may differ. I argue that, independent of duress, YES, they do. As an analogy, if every driver decided to ignore the laws (breach the contract) to which we agreed to upon getting our license whenever they felt like it, then there would be mass chaos and probably many more deaths. Is there a moral obligation to obey the laws that help prevent deaths?
        The consequence is _only_ that they get a ticket… until they kill someone. Is there a moral obligation to obey the laws which otherwise lead to social collapse?

        — With respect to any bailout
        I believe that, in CA at least, purchase money is non-recourse and that a refinance (whether cash-out or just for rate and term) is recourse, allowing the lender to come after the borrower for any deficiency.

        — With respect to debt cancellation (aka debt forgiveness), how many people really understand that ignoring the tax consequences is only at the Federal level and that CA is not playing along right now. At 9.55%, that can hit alot of defaulters _very_ hard.

      • Sean O'Toole says:

        Great points again, though I’d argue there is a difference between obeying laws, and contracts. A law is put in place through a process which, at least in theory, represents the will of the people. Even then I have a hard time with the idea that speeding is immoral. 🙂

        Don’t get me wrong I absolutely believe there should be consequences to not honoring one’s agreements. My point is that there are consequences (like the CA tax consequences you mention), that those consequences were agreed to up front, and that they are between those parties. Adding the consequence of moral condemnation seems to me to be unnecessary and ultimately counter-productive for the reasons stated in my post.

        While refis are recourse loans, in practice they are non-recourse because a deficiency judgements can only be pursued through judicial foreclosure in CA – a practice which is rarely time or cost effective (any loan foreclosed on through non-judicial foreclosure becomes non-recourse thanks to the one action rule).

      • CJ Johnson says:

        If we took all the TARP money and the Billions and Billions we keep shoveling to Fannie & Freddie to keep them afloat we could have recast most of the mortgages with negative equity once and only once to the current market value with a fixed rate loan say of 6% and they if anyone missed two payments in a row they move out of the house in 30 days PERIOD! This would have been fair to those in trouble and those that actually pay their bills. No one has ever suggested such an outlandish idea now have they?

  • Lorrie says:

    With respect to the conversation regarding those who refianced, cashed out and spent the money on vacations, boats, cars. My hubby and I refianced for the sole purpose of fixing up our home. No vacation, car or boat was purchased. We spent every dollar we cashed out on home improvements. How does a person give that back to the bank should we decide to walk? I’ll tell you how. They get the house back. Period!

  • Lorrie says:

    One more thing… We reserved the right to walk away because included in my monthly payment were MIP’s. You tell me what is really fair.. The lender is protected should I default with insurance (MIP’s) I pay for every month that protects their interest (the house) plus the lender gets the house back to sell again, plus the lender can get money for their so called loss from the government. Now, you tell me if that’s fair? There’s big money to be made in forclosures. No wonder most lenders are not very willing or seem like that have much of an interest in modifications.

  • Nancy Hughes says:

    Sean is absolutely right, and I am glad to see him use his platform to educated people – and hopefully the Lenders and Government officials – that the banks need to take responsibility for the bad loans they have made. Basic economics teaches that a property is worth what it can rent for – and the loans in our area (Southwest Riverside County – Temecula and Murrieta) were often twice the amount that properties could rent for. There is an excellent study by Brent White, Esq. of the University of Arizona, “Underwater and not Walking Away: Shame, Fear and the Social Management of the Housing Crisis” that addresses this same subject. He agrees that the lenders have made poor business decisions, but are trying to strong-arm borrowers to continue making payments by using guilt, even when it is the best interest of the borrowers to walk away.

    If the lenders would accept this responsibility – then start to make meaningful Mortgage Modifications including substantial Principal Reductions, we might see the housing market really turn around. The banks would make more money if they can turn a foreclosure into a performing loan – often in the range of a 25 to 35% higher return.

    One has to wonder why the banks are not making what would seem to be the wise business decision. Perhaps they are waiting for the bailout funds – part of the $75 Billion that HAMP has dedicated to providing Modifications for 3 to 4 Million borrowers…

  • Richard says:

    My wife and I have been buying foreclosures for just a year. In that time, we have purchased 7 houses. They were a mix of rentals and owner occupied homes. None of the “stories” were of people who lost their jobs, had illnesses, etc. I have no issue with them walking away. They will take the hit on their credit.

    But what is a problem, is that many have played the system and the victim mentality of the Obama administration to the limit. Living in these houses or collecting rent right up until they were asked to leave by us.

    Trying to renegotiate the terms on a contract does not have to be written into the agreement. In business, it is done all of the time. When it makes sense to both parties to make a change, then it happens. When it does not, the contract exists to enforce performance or each party.

    It does appear to me that the banks are a bunch of idiots and could do a lot to protect their investments and our tax dollars. People seem surprised when I tell them that we could not inspect the house, did not know what the opening bid was until 30 minutes before the auction and that we were drilling out the locks because we were not given keys. It is as though the lenders went to a consultant and asked them to come up with a process that would guarantee that they get the least amount of value for the house as possible.

    As for the moral issue. All of our houses were distressed or trashed in someway. The damage ranged from lack of maintenance to outright vandalism. Removal of appliances, damaged tile, cabinets, etc. Walking away is fine, but until I start to find a well maintained foreclosure, I think it is a person of low integrity who would destroy property on their way out.

    • lorrie says:

      I could care less about the banks and the lending institutions! If you want to talk about morals, lets look at them first because it was their greed and their lack or morals that got us in this housing mess in the first place. Granted many people applied for loans they couldn’t afford but the banks, etc are gatekeepers and a certain level of responsibility regarding lending practices is expected from them. Their greed and lack of morality is why the housing market is in the mess it’s in now and yet, they get bailed out, handed a silver spoon for all their dirty deeds while the rest of us are struggling just to keep the lights on. I have no symphathy for them and if some of them just went away we’d be better off. The whole system is corrupt. It’s not fair to blame homeowers for walking away from a bad mortgage. Not all of them purchased money for loans they couldn’t afford and not all of us cashed out our equity to go on vacations etc. We cashed out with the intent of fixing up our home because we have been told money spent on improvements was an investment. Ha! That’s a joke. Most of us have crunched the numbers and it doesn’t make financial sense to continue on with a mortgage that is so upside down. At my age, 51 it will be at least 12-15 or maybe more years before we break even. We’d come out better if we walked away now and just saved the difference between rent and what our mortgage was. If we stay in the home, we will have not saved money and will still own on a home that is worth less than is owed. Morality has nothing to do with it. It’s just business and what’s in my best interest.. after all, if I don’t watch out for me, who will? Certainly not the government and especially not the banks.

  • mefron says:

    Those of you who took out loans: Why did you take out loans you couldn’t afford to pay back? I’m not talking about what you did with the money. I’m talking about making a responsible decision. Are you adults?

    • Sean O'Toole says:

      mefron – you seem to forget that at the time most “experts” were telling these people to buy a home, that the bubble wouldn’t burst, that if they got in over their head they could always refinance or sell and worst case they’d make a buck on the appreciation. Remember? Prices were going up so fast it didn’t matter if you could afford it, as you’d always be able to sell. Or at least that’s what they said.

      One out of 10 homeowners in CA has now stopped making their payments, 1 out of 3 is underwater due to prices being pushed beyond reason by unsustainable lending practices. Pretty hard to suggest this is all due to borrowers not being “adults”.

      I totally get why renters and savers who didn’t listen to the experts and instead did the right thing are angry. But focus that anger on the folks that made these loans available, and the experts (think congress, fed chairman, etc) that told people adjustable mortgages were ok, and that the bubble wouldn’t burst.

  • Robert says:

    Sean makes an excellent point. And if I recall correctly, it was Barney Frank denying that lending should be reigned in and that he didn’t see any problems with Fannie Mae / Freddie Mac. Of course, I believe it is now the same Barney Frank saying that we need to save Fannie / Freddie.

    We need less career politicians and more true statesmen.

  • loanmesaranch says:

    I must say that all this bantering makes no sense to me. At the end of the day a consumer purchases an item that they can either afford or not. While there was a lot of creative financing there was also plain vanilla product. Many of the loans that have bellied up were plain vanilla and granted had unbelievable low qualification standards. For example DTI > 55%. However with that said consumers did not act sagaciously. Why would you think that you can pay for things that you purchased and only have 45% of your gross income remaining. There are such budget items as food insurance, gas, taxes etc. I personally think that we have created a society of ” let’s have one up on the Jones family” mentality. There is no patience and no accountablity. I remember a story my dad told me during WW2 about cigarettes. Today we know that cigarette smoking is bad and everyone thinks that it was a big secret that it was hidden by the cigarette manufacturers. Well he knew as his friends did, it was bad for them but chose to smoke just the same and suffer the consequences. This applies to anything that is done in excess. We as humans are all responsible for own actions If we choose to live with excesses than there are consequences. I think what has transpired in this day and age is that the generational mentality is all about themselves and if it doesn’t fit in what is deemed relevant it becomes a non issue. Let’s throw away spouses, jobs, homes etc. Very disposable because we are no longer tough and don’t know how to see things through. Society has become soft and as a result we have behaviour which reflects this type of attitude and discussion . It is about morality. A home is not an investment vehicle and it really shouldn’t matter if the value is up or down. It is a place you live, It is a place you chose to purchase and it is a debt that you chose to take on. Granted circumstances exist that preclude you from repayment( loss of a wage earner, illness, etc) but just wanting to “strategicly default” because the house prices have declined isn’t one of those reasons. Banks only lend if there is a market to lend to. If consumers had the strength to say no then banks would not be ailing and on the converse if banks would not of offered then the banks would not be ailing. No one entity is more at fault. So with that mouth full bottom line is if you borrower money whether through a contract or a handshake you are morally obligated to repay it. All the excuses in the world ( including stupidity)will not change that!

  • Lorrie says:

    loanmesaranch- you don’t get it and I’m sorry but it’s not your job or any one’s job to tell me or anyone else for that matter what my moral obligations may or may not be. It’s as individual as religion and sexual preferences because what suits you may not fit nicely in my life.
    I never said I couldn’t afford the payment. I didn’t buy a house with a payment I couldn’t afford.
    A persons home is suppose to be an asset not a liability and anyone with any business sense knows to dump a liability. I’m not going to slide into my 60’s owing more on a home than it’s worth. You got to know when to fold em. When to cut your losses and move on.

  • Robert says:


    Please refer to http://en.wikipedia.org/wiki/Morality

    The interesting thing as I see it (in light of the wiki description), is that yesterday, it was quite immoral (contrary to social norms) to walk away. People who did were making a financial decision vice a moral decision.

    However, with as many people as have walked away, we already notice that there is no longer the same social stigma associated with short sales or foreclosures and that as a result, by the very definition of morality, social norms are changing.

    It would seem that all this dicsussion exists only because we are transitioning between two stages of whether or not it is acceptable to walk away.


  • Brent says:

    Haven’t read all the posts here (some of which may have vetted my point thoroughly). I’ve got no issue w/ people not making payments and losing their homes as a consquence. That’s how the contract mechanism works.

    But, what about those underwater borrowers not making any PITI payments and continuing to live in their homes for over a year or more while they evaluate mods, short sale, bankruptcy, or any other maneuvers to stave off foreclosure? How nice to squat and live occupancy cost free. These borrowers should have moved long ago and now be renting, but they’re not b/c the system has allowed it to be so. What about all those renters seeking to own, who’ve been patient, paying their rents and can’t find a home b/c inventory levels are shrinking due to foreclosure preemption efforts?

    This problem is growing and will cause artificially high GDP #’s since borrowers have basically cut 1/2 their costs out of their personal expense budgets, making those $ instead available for retail expenditures, travel, etc. This issue is exacerbated when the underwater mortgage is a re-fi vs. purchase $ – the borrower pulls cash out of the house ATM, overdraws the balance, and is able to sill draw cash out via not making any more PITI payments?

    This rescue effort is a joke.

    What if the good borrowers forced the hand of moral hazard and did the same thing? If 15 – 25% of the population with mortgages are doing it, why shouldn’t the rest of us borrowers.

    • Sean O'Toole says:

      Great point Brent. I think it will be very interesting to see if the public’s, and the politician’s mood changes from wanting to help keep people in their homes, to getting them out and moving on. I see some public sentiment in that direction, but zero political shift so far.

  • Robert says:

    Look out… we’re getting into politics now. I for one would love to see more statesmen than career politicians. I thought the following quotes from Thomas Jefferson were mildly relevant and worth sharing.

    Truth is certainly a branch of morality and a very important one to society.

    In matters of style, swim with the current; in matters of principle, stand like a rock.

    A democracy is nothing more than mob rule, where fifty-one percent of the people may take away the rights of the other forty-nine.

    I predict future happiness for Americans if they can prevent the government from wasting the labors of the people under the pretense of taking care of them.

    Experience hath shewn, that even under the best forms of government those entrusted with power have, in time, and by slow operations, perverted it into tyranny.

    Whenever the people are well-informed, they can be trusted with their own government.

    It is incumbent on every generation to pay its own debts as it goes. A principle which if acted on would save one-half the wars of the world.

    We may consider each generation as a distinct nation, with a right, by the will of its majority, to bind themselves, but none to bind the succeeding generation, more than the inhabitants of another country.

    Whenever you do a thing, act as if all the world were watching.

  • CJ Johnson says:

    What is really interesting is that the entire discussion seems to revolve on the moral obligation to pay or the big bad bans moral obilgation (not sure if that even is a valid issue) when they made the loan. How about adding another factor. So long as the lenders and the homeowners are each bailed out of their obligations under the original agreements those of us who pay our taxes will pay off these bad debts in the end. Now how is that Moral to the us?

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