On scales of norms

There has been more blogospheric discussion on the topic of my post Doing the right thing, doing the legal thing. Megan McArdle, who started the discussion, has a long post elaborating on her objections to strategic defaults. Steve Waldman has two good posts up. Finally, at The Big Money Daniel Gross concludes:

Of course, corporate managers and financiers don't suffer from these neuroses. Do you think billionaire investor Sam Zell feels any guilt or shame because his buyout of the Tribune Co., which had $12.9 billion in debt, ended in a Chapter 11 filing last December? Rather than worry about whether Americans will take cues from modest homeowners who make a tough decision not to stay current on debt, perhaps we should worry about middle-class Americans taking cues from billionaires and Fortune 500 companies who make the rational decision not to stay current on debt.

As I admitted earlier, as a matter of description a society where people are relatively trustworthy, and do the right thing as opposed to the legal thing, is a happier place than one where trust is in short supply. The problem is that these societies don't emerge out of thin air, but are created though vigilant policing of norms, and frankly a level of interpersonal nosiness or homogeneity which is probably considered uncouth or retrograde today.

Perhaps what we saw in the last generation was the slow but steady exhaustion of values which arose in the context of small towns and urban neighborhoods. With the decline of the small town and the decay of close-knit urban neighborhoods perhaps the modern state is one where atomistic rational actors are intent on doing what they can get away with because of the anonymity which is the normal course of existence. The power of modern media means that Americans, no matter where they live, see how the high and might live and how they comport themselves in their peer groups. The "community" has now expanded into cyberspace and the norms are not just created by interaction with those whom you meet face to face.

Instead of demanding that Americans stay true to the values of old, and basic decency, I think it is perhaps time to engage with the future which we are facing. The horse of old-time values has left the barn. Perhaps more transparency in personal records and immediate access by anyone in relation to anyone will bring back some accountability to the choices one makes.

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I still say that before I get worked up about strategic defaults (which have been discussed on the econo-blogs for quite a while now) I'm going to need to see better evidence that it's really a widespread problem. For example, in the original article that sets off McArdle, she just _assumes_ that the subject of the article can afford to pay, but in fact the article states that the borrower has been losing rent income. You could just as easily assume that she cannot pay. (Newspaper articles like this are notorious for being vague and incomplete about these sorts of details. They definitely don't count as evidence.)

Also, I'd want to know _who_ is defaulting: homeowners? Investors (speculators, flippers)? I'd be willing to bet money that a lot of strategic defaults are not for primary residences, but investment properties. (And you'd have to check closely: a lot of flippers lied about that to get better rates).

And now is an odd time to complaining about this. Was McArdle complaining about liar loans in the past? Appraisal fraud? Deceptive loan practices? Loan officers gaming the underwriting systems? Every possible cheat you can think of was employed in the bubble. Now you suddenly expect people to do the right thing?

You want a simple way to stop strategic default? Require 20 percent downpayment for any home purchase. Most people won't walk away from that without exhausting other options.

While there may be something to what you say (the values of small town America - even when it wasn't in small towns) I'm overall skeptical of your pessimism. I think we've seen some big upheavals the past 10 years. (War, 911, polarized politics, recession) When things calm down I suspect we'll return to having a more civil society.

Strategic default has major consequences. It destroys your credit. Leads to Bankruptcy. And since we're talking about individuals, not corporations, there's personal liability and tax consequences depending on when and where you default. So morally speaking an individual is punished severely for what is often times a legal, but necessary evil. Plus we're talking about Real property as collateral to back the loans...the banks receive the property which in the end is the deal. You may have more of a case with unsecured loans where it truly is just your word and credit history. In general, Keeping a property that lost more than half it's value also has consequences for business. If homeowners are losing a thousand dollars a month of disposable income to a property most likely underwater at purchase (just inflated in value by the bank's appraiser), they're not putting that into the main street economy that produces jobs, tax revenue, growth. Fraud, shady deals, or lies should be dealt with by law enforcement, minus that, let's not get so high and mighty against the little guy. As for flippers or people who own rental property...you can't do the moral argument on them because they're basically a small business. Small and big businesses default all the time...if defaulting or reorganizing is in the best interest of the business then they a have a fiduciary duty to do it. If stategic default is so morally objectionable we can go back to debtor's prison and indentured servitude... that's a choice voters can make. Banks don't give loans anymore because of morals, they give loans based on statistics, actuary information and the pursuit of fees and obscene profits. I guarantee you if homeowners got the kind of sweetheart deal that Wall street got then we won't be having this discussion. If all the Foreclosures that destroyed Equity were purchased at 2006 market rates by the government we wouldn't be having this discussion. If normal small business Joe Shmoe could borrow money at zero percent and have the government prop up all Joe's customers so they could continue to buy Joe's product at inflated prices, while making sure Joe gets Millions in compensation (money is fungible) we wouldn't be having this discussion.

Economic rationality as defined and taught in the universities is purely self-interested, and for a long time people in business have been pretty cold-blooded, especially the bigger players. (At a certain size, your lawyers can beat anyone else's, including the government's; ethics is swallowed up by prudence, i.e., "what can I get away with?") Small time entry-level startups also, in my experience, will resort to criminal practices rather than fail, and plenty of successful criminals use their proceeds to start legit businesses.

This has been true for a century or more. A century ago laws had to be passed to keep processors from putting poison in food -- arsenic makes peas look fresher, but arsenic is a cumulative poison. "Caveat emptor" was the law of the land: if you buy it it's your problem.

The old ethical world was two-level; the leaders preached strict ethics to the commonfolk, played by different rules themselves. That's almost a cultural universal, but if the upper classes get too corrupt there can be consequences.

Republicans get a big chunk of their votes from people who play by strict rules and think everyone else should, whereas the Democratic Party is the party of indulgence -- that's what many people think of when they think of liberalism, letting people get away with things. But high level Republicans play by the high-level rules, not by the ranbk-and-file rules.

As far as that goes, "prosperity theology" conservatives seem to be very lax and indulgent toward their own people, as long as they repent frequently and "sincerely". (The Republican C Street House in DC seems to be a rehab center for big-time Republican whoremongers.)

By John Emerson (not verified) on 23 Dec 2009 #permalink

I was going to say, to the average person bankruptcy is a moral question if you owe money to an individual, but not if you owe money to a bank. In part this is because if you borrow from someone you know, you're relying on a personal relationship and it isn't pure business; a lot of other stuff enters in. People who default on personal loans in face to face communities can feel life-long shame, and often they're held in contempt within the community.

Many small-town types feel the same way about bank loans, but they're suckers. Businesses don't work that way. McMegan tends to go between hard core self-interested libertarianism and pious small time moralism in an ideologically opportunistic and inconsistent way. In general she strikes me as remarkably ignorant, thoughtless, and semi-educated.

When corporations gained the rights of persons, but not their obligations, Populists and others objected mightily, but to no avail. Originally it was done by judicial fiat (one that conservatives don't object to), but as I understand it was later written into law.

A corporation which recognized ethical principles beyond the legal obligation would be sued by shareholders for violating its fiduciary responsibilities. A corporation's obligations are only legal and financial -- it optimizes profits, or growth, or market share, or some other economic quantity, but it does not make ethical choices.

Some to day want to take away corporate personhood, but that idea has a snowball's chance in hell. It they could, the corporations would deny non-corporate personhood.

By John Emerson (not verified) on 23 Dec 2009 #permalink