Strategically defaulting on a home loan
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TESS VIGELAND: Here’s an encapsulation of the confusion that still reigns in the housing market. On one day this week, we found out that home prices rose in November. But the next day, a different indicator said sales of new homes fell in December. Meanwhile, more and more people are just deciding to cut their losses. They’re walking away from their mortgages. Can’t or don’t want to pay, so bye bye.
Linda Giella of Venice, Calif. is one of them. She owns 11 investment properties.
Linda Giella: My husband works six days a week, 10 hours a day, just trying to make enough money to cover all these mortgages each month. And it just doesn’t seem worth it anymore. I mean, he’s killing himself. As far as I’m concerned, the contract is you pay monthly, or we take back the house. So, they’ve already gotten plenty money, and they’re getting the property back. So I don’t see anything dishonorable about that whatsoever.
Vigeland: But is there something dishonorable or immoral about walking away? Joining us now to debate that question are Henry Blodget, CEO of the “Business Insider” and Megan McArdle, a business and economics editor at the “Atlantic” magazine.
Welcome to both of you.
Henry Blodget: Thank you.
Megan McArdle: Thanks.
Vigeland: So any first reactions to Linda and her specific situation, Megan?
McArdle: Well, I think there are a lot of issues implicated here. One question is, can they actually afford these mortgages? I mean, there is a point at which if you’re dipping into savings, you should walk away from your mortgage. But the question is, if you can afford it, should the bank be the one to eat the loss? It’s not one of those things where the bank gets a choice of one of two free gifts, the payment stream, or the house. The house is simply what they get to take after you have breached your contract. And the very fact that she doesn’t want the houses, because they’re not worth what she paid for them indicates the bank probably doesn’t want them either.
Vigeland: Henry, what do you think?
Blodget: Linda is exactly right. Because what she is is a real-estate investor, she has gone out to a professional firm and borrowed money to buy the investments, that firm totally understands that circumstances change and in this particular case, I would say Linda and her husband are real-estate speculators. They got burned, they are going to default on their loans, which is going to create all sorts of problems for them down the road. There is no above and beyond that moral obligation, or promise to pay, that goes beyond what a corporation would have when it borrows money from investors.
Vigeland: Well, there does seem to be this growing debate recently about the morality of walking away from a home. So let’s talk about this really most basic question: Is this a moral issue? Henry?
Blodget: I think that there’s definitely a sliding scale. Megan and I have talked about this issue before, and she has pointed to people who are simply rampant speculators, who are gambling on the bank’s dime and gleefully skipping away from mortgages, because the bet didn’t work out and so forth. At that end of the scale, sure, somebody is abusing the system.
But there is a big sliding scale and as you get toward the middle of it, if you’re so strapped by the way the weight of the mortgage that you can’t save enough, and it’s really impacting your family life and so forth, certainly you can consider walking away. And there are huge ramifications for that and reasons not to do it, but one of them is not that it’s an immoral act.
Vigeland: Well, Megan, Henry talked about that sliding scale. Where do you put this? Is it a moral issue for you?
McArdle: If you are in a place, where you actually can’t pay, then you should probably walk away. But I have some questions. For example, how did you get into that spot? Did your income take a hit or did you have an unrealistic mortgage, because you were using your house like a piggy bank? What I actually worry about is that right now I think we’re in a very good equilibrium. People try really, really hard to pay off their mortgages. That makes it relatively easy to get a mortgage, and it makes it relatively easy to have rules that make it possible to get out of your mortgage if something goes wrong. And we do that, because Americans have a pretty strong internal sense of shame about not paying debts that they could pay.
Now, if that equilibrium changes, what does it look like? Do we just get to walk away from our mortgages and nothing else changes? No. What happens is that then probably the rules change — they get bankruptcy made tougher, they write the contract so that they’re tougher. And the upshot of that is that the people who really need to walk away get damaged.
Vigeland: Well, Henry what if we do get to the point where there isn’t shame in walking away? Which it kind of feels that that might be happening, that there is a sense that “Well, you know what? It’s just a business transaction.”
Blodget: Well, I think in a lot of ways it is just a business transaction. I think that’s the point that I’d make. And one example that I’d bring up is how it’s so different with corporations, as you just had the biggest residential complex in American history that was defaulted on. This is Stuyvesant Town in New York, where the folks who bought it, who were total professionals, said, “You know what, we can’t pay the loans anymore” and they walk away. And so everybody looks at that and says, “Corporations do that all the time.” In none of the articles that I saw written about this was the word “morality” ever raised. This is simply something corporations do. The only person that is being asked to be a moral being is the individual.
Vigeland: Megan, it certainly does seem like there’s a bit of a double standard, isn’t there?
McArdle: I think that you have to look at what were the norms under which the money was lent. I would argue that the mortgage lenders lent money into a market in which people try really hard to repay their mortgages. I think banks really did have the expectation that the norm that prevailed in mortgage markets was you try hard to repay your house if you can. They did not think that what people thought they were doing was taking out an option to have the upside on the appreciation of their house and/or let the bank take all of the downside. And so you’re changing the norm in the mid-game.
Blodget: I think that you are saddling, you’re putting an unfair amount of that morality on individuals. Why doesn’t the bank have the moral obligation to say, “Hey, this homeowner is strapped. Things haven’t worked out the way they thought it would or we thought it would. Let’s help keep them in their house. Because, by the way, it’s really going to suck for them to have to move.” Why isn’t the bank saying, “You know what, we’re just going to cut your mortgage in half, because for us, it’s just a little write-off that’s going to disappear, no one will really notice. For you, it’s disrupting your entire family, your school system and so forth.” This is why I just don’t think it’s fair to act as though the individual is the only one that has some sort of moral code here.
Vigeland: But Henry, what happens if more and more homeowners go this route, they walk away? I mean, what does that then say about us, when a contract is no longer sacred?
Blodget: The contract is absolutely sacred and what I’m saying is that that’s why the contract is there. It is to specify what happens if you do not pay. You’re not ripping up the contract and saying I refuse to honor it. That’s what it’s there for, it specifies exactly what happens in this case.
McArdle: Wait a minute. Now, if your cell phone provider just like unilaterally breached your contract and they paid whatever $50 penalty was in the contract for that, would you be like, “Oh, that’s OK,” because they had this penalty in the contract and they can pay me the penalty? Or they can live up to the contract they signed. Would you be like, “Well, but it’s corporate.” No! You’d be furious. I would be furious, I would be on my Web site telling the entire world that they were a bunch of lying, cheating deadbeats.
Blodget: It may be a very bad business decision for them. It’s a very bad business decision for an individual who wants to borrow money in the future to walk away from debts. That’s a terrible business decision. Shatters your credit rating for seven years and so that’s what you’re saying, is this corporation runs around willy-nilly, “Hey, we’ve got a little fine print line that we’re going to invoke here and infuriate our customers,” it’s often a very bad business decision. I’m not arguing that it isn’t.
McArdle: I don’t care if it was a bad business decision. It’s wrong. It’s not just a bad business decision.
Blodget: If it’s in the contract, it’s not morally wrong. It’s what a contract is for.
Vigeland: Megan, any chance here that maybe strategic faults send a message to the banks?
McArdle: Yes, there’s a lot of anger at the banks, but a. there’s no indication that these people are going to match that to banks that have been abusive. A lot of these securities are held by pension funds and institutions. So you’re going to send a message to the Red Cross, “Oops, shouldn’t have invested your endowment in mortgage-backed securities or CalPERS.” And I think that you know, it’s not matching the punishment to the problem. If we think that banks have been abusive, we should curb those abuses, not just go out and start being freelance bank regulators.
Vigeland: Well, I’m sorry guys, that’s all the time we have. I have to walk away from this interview. So thank you so much for you time.
Blodget: Thank you for having me.
McArdle: Thanks a lot.
Vigeland: Henry Blodget is CEO of the “Business Insider” and Megan McArdle is a business and economics editor at the “Atlantic” magazine.
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