Doing the right thing, doing the legal thing

Megan McArdle has a post up where she follows up on her disgust with home owners who "walk away" from their mortgage obligations when they can continue to pay them. In California, and many other states, the bank can't come after you if you walk away, so if your home is "underwater" then it is often a "rational" decision.

Megan makes the point that our economic and social system does not rely purely on rational self-interest, but also on an accumulated capital of norms which lead to virtuous cycles. My family is from Bangladesh, and I have seen this first hand. Corruption & nepotism in Bangladesh are almost impossible to change because it is stuck in an equilibrium state; if you are the first person to not be corrupt or nepotistic you're only causing hardship to your family and relatives while others prosper. As an example, I have an uncle who works as a civil servant and has been promoted to a relatively high position because he is known to be someone who refuses to take bribes. The reason my uncle does not take bribes is mostly due to family tradition,* and, I suspect some personality quirks inherited from one of my grandfathers (he was a notoriously guileless individual, and that tendency has passed on to some of his children). Though his clean reputation means that he is in high esteem in the eyes of his colleagues, it is also a running joke that all of his subordinates live in palatial homes while he has a modest apartment! This causes some awkwardness because he simply can not entertain any of his subordinates since his material condition is so inferior to what they are accustomed to. In terms of innate moral character I doubt my uncle is elevated in any particular way from his colleagues and subordinates. Rather, he has an idiosyncratic and plainly irrational set of norms when it comes to maximizing his material wealth.**

Cultural norms can shift through positive feedback loops, and changes are not always reversible. Dan Ariely has reported this from his behavioral economic research; once you turn people into pure utility maximizing rational actors it is often hard to reverse their decision making heuristics so as to take on a softer edge. Anyway who wants to see the canonical shifts from vice to virtue to collapse to virtue repeatedly need only study Chinese history. From a purely utilitarian perspective I think Megan is correct. A sense of personal responsibility and norms which assume that one has a responsibility toward one's fellow citizen beyond and above the call of the law can help ameliorate collective action problems and increase aggregate utility. noted by some of Megan's critics in the comments of her posts, the problem is that we aren't utility maximizing machines, rather, we have an innate sense of justice and inclination toward spite and retribution. Over the past few years it is clear that at the commanding heights of the American economy a substantial number of individuals were acting their own rational self-interest, within the letter of the law, while at the same time sacrificing the collective interest. Last year when I was reading about the collapse of LTCM in the late 1990s I learned that one of the traders, Eric Rosenfeld, nearly scuttled the bailout which rescued the financial markets from chaos because he was weighing whether it was in his personal interest. Because he was a partner his consent was necessary under the law. The bigger point is that there's a perception in the American public now that the the elites of finance are corrupt and extract all they can get out of the system with full knowledge that they're backstopped by the credit of the American government and have access to cheap government money. It's all legal.

So I guess what I'm saying is that without elites who have a sense of virtue it is going to be really hard to maintain a moral window on personal behavior. This isn't a matter of judgement, I think it's a description. The people who are "walking away" are probably leading indicators of the sort of rational behavior which will become the norm as people realize that that sort of selfish behavior is spreading. In some communities with a strong spirit of collective identity and leadership from the top perhaps ostracism will prevent rational behavior on the individual level which might be a liability in the aggregate, but I suspect that more often many average Americans will simply justify their behavior to each other by pointing to the fact that a substantial number of elite Americans have no hesitation of screwing them if they can and it is in their interests. In other words, it has gone from what should you do, to what can you get away with. Of course this is a vicious circle, and not good for anyone.*** But that might not matter.

The financial sector is systemically important for a healthy economy. But a sense of virtue is systematically important for a healthy society. Bailing out the former has resulted in pulling the rug out from one of the perceptions which has buttressed the latter; that those who do well do so because they do good.

Related: The Harvard-Goldman Filter. We'd have a different country if it was the MIT/Stanford-Google/Intel filter.

* I was asked recently if this was not an extremely maladaptive tradition in a nation renowned for corruption. I think the issue here is that this side of my family lived off rents from their land holdings until the recent past, with many of the males holding positions of religious leadership due to the leisure that their income provided.

** Other family members went into professions which would minimize the necessity of corruption, at least as practitioners.

*** There are industries which make real things and provide real services.

More like this

Of course, it is still hard to get at firm data as to how many people are really "walking away" from mortgages they could afford to pay but choose not to. Almost no one will actually admit to doing it, and it is surely not happening at the rate that pure selfishness would dictate. Consider the difficulty being faced by the loan servicers trying to make loan mods--they have to verify income and other information, and in many cases--possibly even a majority of cases--the mods don't happen because the income can't be verified (sure, the lenders could have done that _before_ they gave out the loan, but they were all too busy then to bother with such details). So if we can't verify the income of people in default, how do we know they're "walking away"? We don't.

For instance the Wall Street Journal ran some data from Experian in which Experian estimates the percentage of defaults that are strategic, and the way they did this was to look at the number of people who were in default on their mortgage but were paying their other bills. The assumption is that if they can pay their other bills, they can pay the mortgage too. But this is not necessarily the case. Now, it used to be that people would pay the mortgage first, and let the other bills go, so this may be indeed a behavioral change, but it doesn't mean people in default aren't in distress.

That said, who is now admitting to walking away from properties they can afford but don't want to pay for now that they're underwater on the loans? Morgan Stanley. They're giving up 5 office buildings they paid $6 billion for. Of course, the folks they're stiffing is the Blackstone Group. No honor among thieves, and all that.

While I would generally agree that people should abide by their agreements and pay if they can pay, bankers are the last people in the world who should be handing out lectures about financial responsibility. They made this bed, now let them lie in it.

I read the article and I am at a loss as to what is "immoral" about walking away from a mortgage where you owe more than the house is worth. Isn't it almost immoral NOT to do so? If you you don't walk away there is no incentive for banks to actually give mortgages that reflect an accurate price on a home rather than an inflated one. Isn't this kind of thinking partly what got us into the mortgage mess in the first place? I would almost call it a duty to walk away from a loan like this. It is in no way like taking a bribe or anything like that. That is a totally false comparison to me.

If you don't care to live in the house so its utility to you is less than what you owe and the the hassle of giving it up is not enough barrier than what you are doing by staying is artificially keeping the price of homes for new buyers too high - not reflecting their real value. That means that people who could afford homes can't, and those who can still afford the homes are transferring their money to the banks for no value.

I forgot to mention an important factor. In Ye Olde days, it was unusual to get a home loan without a substantial cash downpayment. In recent years, of course, this was eroded to the point where most borrowers were buying a house with little or no downpayment. Rather unsurprisingly, one thing we can say fairly certainly is that there is a strong correlation between downpayment and default risk. Borrowers without money are more likely to get in trouble with a loan (duh), and borrowers who paid out a lot of their own money to buy a house work harder to keep the house. Today, people have no personal investment in the house; it's all borrowed money.

This isn't exactly a new development. Within living memory, most workers could expect to stay in the same firm for their entire lives. Loyalty between employer and employees was a fairly reliable two-way street. (Recall that IBM prided itself on having never laid any of its employees off.)

The rounds of layoffs in the 70s changed that. I recall when Motorola bragged that employees with more than 20 years of seniority were very safe indeed, and held out their "no layoffs after 20" policy was a reason to stay with the Company even when considering better offers. It would, after all, take a vote of the Board to remove a 20-year employee.

On 1 April 1975 [1] the BOD scrapped the policy and laid off a long list of 20-year employees. The same story was repeated in companies all over the USA.

For decades afterwards, corporate management complained about a lack of loyalty among employees, usually after a round of layoffs when the survivors left for better offers.

[1] Appropriate, no?

By D. C. Sessions (not verified) on 18 Dec 2009 #permalink

This is a big and extremely messy question. Some degree of corruption is probably inevitable in any large, complex economy, and often quite a high degree. Stratification is certainly inevitable, in the sense that there will be a few very rich people and a much larger number of very poor people. These aspects can be minimized or maximized, but they're always there.

These arguments were fought out in the US between about 1880 and 1940, and by and large the advocates of public morality lost. From 1880 on the dominant position both in the ruling Republican Party and in the Democratic Party was that encouraging economic growth was the important thing, that high-level corruption was no big deal if it encouraged growth, and that questions of equality and social justice should not even be raised -- not the business of limited government. These principles have never entirely disappeared.

Populists and Progressives of various sorts (some within one of the two parties) challenged these principles, but they were usually defeated and never dominant, and at best they succeeded in trimming a little around the edges. During the New Deal they were an outside force, but because of the Depression they had to be listened to, but once the crisis was past (and once WWII started), they faded. They've never really recovered, and at the present time both the Democratic and the Republican parties are strongly anti-populist (though both occasionally pretend otherwise.)

The Populists and Progressives were distinguished by their application of moral principles to public, political, and economic life, and for this they were not only ridiculed, but accused of being either naive and unrealistic or else fascists and/or communists. (One such person, William Lemke of ND, after 18 years in public office and another 17 years as an important party leader, still had not paid off his house, at ND prices. He was a talented lawyer but did a lot of pro-bono work).

Tough-minded pragmatism and technocracy became dominant everywhere. Both parties were run by suavely realistic businessmen, and the Democratic Party had affiliations with corrupt urban bosses and unions (though it should be noted here that after a certain point the Teamsters were Republicans as often as not).

The old competitive free-market individualistic moralism survived in the Republican Party, but there's always been a split between the beliefs of the rank and file and the actual practices of the top leaders.

Liberals, in the context of this, are anti-populist anti-progressive realists and technocrats, a branch of the party that already was important in WWI and became dominant after WWII.

From one point of view, it's best for the mass to be moralistic and dutiful while the rulers rule realistically if not cynically. This only works if the mass is unaware of what the rulers are doing, and if the rulers somehow discipline themselves enough to avoid bringing the whole system down. Both these conditions are hard to satisfy.

These dynamics tend toward a rise-and-decline dynamic, with societies becoming more messy and more corrupt at every level until finally they become unviable. The timing of all this is uncertain, however, so prophets of doom are usually wrong, and societies can limp along in corruption for extraordinarily long periods.

By John Emerson (not verified) on 18 Dec 2009 #permalink

I forgot to mention about Lemke: before WWI he accumulated some debts in a speculative business venture. These were personal handshake obligations, so he never declared bankruptcy. It was because he was paying off these debts into the 40s that he couldn't pay off his house.

Lemke's moralistic integrity in business was of a piece with his political extremism. You don't see people like that any more.

By John Emerson (not verified) on 18 Dec 2009 #permalink

not walking away isn't being moral, it's just being a sucker. dignity is more important than so called "norms"

"So I guess what I'm saying is that without elites who have a sense of virtue it is going to be really hard to maintain a moral window on personal behavior."

and there never will be! THAT is the norm.

"I learned that one of the traders, Eric Rosenfeld, nearly scuttled the bailout which rescued the financial markets from chaos because he was weighing whether it was in his personal interest."

as he should have. and all the financial markets were rescued from was orderly bankrupcies. He should have gone with his instinct and not signed on. he would probably be working at a better company

Depending on how the mortgage contract is structured, there may or may not be any moral taint associated with walking away from it. Given that there was explicitly no legal recourse for the lender other than to take back the house, this can be regarded as simply giving the homeowner a "put option" on the house as part of the contract. It's the same principle as in a pawn shop -- if you don't pay the money back, the pawnbroker keeps the item and your business relationship is cordially terminated with no further obligations on either side. What is to stop the homeowener interpreting his contract in this way?

By Joe Shipman (not verified) on 18 Dec 2009 #permalink

A fairly recent change is that walking away used to generate "debt forgiveness income" on which you had to pay taxes (unless you also filed personal bankrutpcy), but Congress changed this a couple of years ago. Before, you would walk away from a $300,000 mortgage but would then owe taxes on the $300,000 that you didn't pay. That was a disincentive to walk away if you were underwater.

as he should have. and all the financial markets were rescued from was orderly bankrupcies.

it's for a reason that Austrian economics hasn't been tried since 1929.

By John Emerson (not verified) on 19 Dec 2009 #permalink

Military officers with families deployed in Iraw lose their life savings in crash and ask themselves what the honorable thing to do would be.


By John Emerson (not verified) on 19 Dec 2009 #permalink

I might just add something intuitive and anecdotal: I've spent large chunks of my life both in a rural, Republican-tending area and in a strongly Democratic blue city, and one big differences I've noted is attitudes toward debt. Rural people are more reluctant to take on debt, even for conservative purposes like buying farm machinery, and they also feel musch more ashamed about defaulting.

Part of this is just that debt has been the farmer's curse for as long as there has been a cash economy. Another reason is that rural people live in face-to-face communities and don't think of creditors as anonymous corporations.

It's much more an urban/rural split than a D/R political split, I think.

By John Emerson (not verified) on 19 Dec 2009 #permalink