Wednesday, March 11, 2009

Mortgages and morality

Alright get ready for a long post because this involves morality, economics, the stock market, my college education, mortgages and, just to make it complete, Google.

Let's go backwards and start with Google, which has a "Reader" that has changed my web surfing over the last couple years by compiling all the website feeds that I follow and I can sort them under various headings such as "trading" (Eric, Teresa Lo and Upsidetrader among others), "economics" (Barry and Macroman among others), "politics" (Glenn Greenwald, Rude Pundit, TPM among others), "news" (BBC, CNN, etc), "culture" (Vanity Fair, TED themes) , "sports" (White Sox, Bears, ESPN, what else is there?) and "science"(National Geographic, Evolutionblog, among others).  This makes following the 60 or so blogs on my list much easier.  Then there is the "fun" category for blogs from which I derive soem entertainment, but really fit no specific category, and Megan McArdle fits that description.  I used to put her in the "economics" category, but she really does not deserve that status, so now she is relegated to the merely "fun"  heading along with other brain candy like Strange Maps and Sarah Sizzle.

I can't remember when I began reading McArdle's posts, but the fact that she went to my old college was surely part of the attraction.  Her MBA is from University of Chicago and I figured she might be able to better explain the Milton Friedmanist ideology that I somehow never grasped during my undergraduate years on that campus.  Another ersatz ideologue, David Brooks from the NYT, was in my class and while I don't specifically remember him from the Political Order and Change curriculum, the meandering and erudite memories of discussing Burke and Hobbes three decades ago often rushes back to me whenever I weave my way through one of Brooks' columns.  Both Brooks and McArdle have been a disappointment and make me even more sure that transferring to the University of Illinois after two years was the correct choice.

Fast forward to this week:  McArdle discusses the moral imperative attached to paying off one's mortgage and her thesis is that folks who walk away from underwater mortgages are an affront to her well-honed protestant work-ethic and destroying the moral fabric of western civilization. She compares walk-away foreclosures to returning a used barbeque grill bought with a credit card.

McArdle takes issue with a criticism of a CNBC show that explores a specific case of "Felix" who calls in to Carmen Wong Ulrich's (how's that name for purposefully extolling your polyglot heritage?) show and asks for advice about his underwater mortgage.  He bought a home for $700,000 with a $300,000 down payment and now the home has decreased in value and is worth only $350,000 and he owes $400,000, and felix wonders if he should foreclose onthe house.  Poor Felix was castigated by the on-air personalities for threatening to shirk his "moral" obligation to honor the mortgage.  He is willing to walk away from his $300,000 investment in order to avoid losing even more on the home.  McArdle joins the pile-on with her own brand of insane logic and complete unknowledge of law and morality, despite her expensive scholastic pedigree.

Here's the problem with the legal line of reasoning which was pointed out in the comments section of her blog: mortgages in most, if not all, states are non-recourse loans which is much different than credit card debt.  If you do not pay your credit card, the law states that banks can garnish your wages, attach your assets and even force you into bankruptcy.  Mortgages are not covered by such onerous laws and thus there is no recourse for walking away from a mortgage other than losing any equity accumulated in the property.  If there is only negative equity, then a borrower would certainly be justified in handing the keys over to whichever idiot banker owns their mortgage.  Thus the second stanza of Mr. Franklin's admonition, neither a borrower nor a lender be.  

A home mortgage is really just a two clause contract: #1) The borrower agrees to pay the mortgage at a certain interest rate over a certain number of years.  #2) If the buyer does not fulfill the conditions of #1, then the lender may take possession of the property.

Banks know the law and they know the implications of accepting crappy mortgages on depreciating assets and I'm sure there is some reason for the different laws, and I will even go so far as to say that the non-recourse nature of these laws somehow benefits the banks over the borrowers. More loans would be taken, more homes would be built and lenders could more easily take that (usually) appreciating asset in foreclosure.  For decades mortgage lenders have enjoyed the simplicity of taking over foreclosures without going through arduous bankruptcy litigation; after a homeowner pays 15 years worth of mostly interest on a thirty-year loan, they lose their job at GM and the bank gets the house... the entire house, which has likely doubled in value and had been "paid-off" years ago anyway.  Simple and clean.  That worked well when houses always appreciated in value and homeowners were required to put 10% down.  That's the reason J.P. Morgan had the biggest estate on Long Island and Angelo Mozillo could afford all that skin tanning lotion.

But banks got sloppy and started accepting mortgages on property that was decreasing in value. Investors accepted the ratings of these securtized loans that were packeaged and sold as products, even thought the ratings agencies had huge conflicts of interests.  Neither banks nor investors did the proper due diligence when allocating assets, so now they want to shame mortgagees like Felix into paying more for the home than it is worth... when he clearly has no legal obligation to do so.

For some odd reason, the years McArdle spent at the midwest's greatest bastion of higher learning has not necessarily honed her critical thinking and has apparetnly prepared her only for carrying the water for the moneyed investor class.   Such humorous reasoning is why Megan McArdle is in the "fun" section of my Google Reader.  

McArdle and Wong Ulrich broach this aspect of morality into the mortgages debate, this idea that borrowers like Felix have a moral obligation to the bank.  Does he?  The contract is a clear statement of the legal obligation, but does the mortgage holder have a further obligation, a moral obligation, to the bank or his neighbors or society in general?  I would posit that Felix' primary moral obligation is to the well-being of himself and his family, and that may not include paying more for a house than it is worth.  Felix needs to weigh the advantages and disadvantages of paying another $400,000 for a property that is worth only $350,000 and decide if things like his credit rating, his lost downpayment and having to move his family to another place (rented, since not even an idiot banker would dare give him another mortgage now) are worth the extra cost. But moral obligation to the bank ot "the house" has nothing to do with it.  I'm not even sure that anonymous owners of an amalgamated asset back security qualify as a moral agents, and if they do, it's far far down on the list of priorities for Felix.

Yes, the deflationary "economic crisis" sucks.  No matter how wealthy or poor you may be, you will likely be affected in some way by the unwinding of the massive debt with which our society has encumbered itself.  Only those with no debt and a stable job will come out relatively unscathed.  If only one culprit could be named, my guess is that the ratings agencies would be near the top of any poll, with banks and investment houses who should have done some due dilly close behind.  The Felixes of the world bear some responsibility, but certainly not the brunt, and certainly a lot less moral obligation than the lenders.  After all, he was merely trying to buy a primary residence for his family-- not an investment property or a flipped-house-- in a housing market that was pumped up with years of easy money which increased the cost the all housing, rented or purchased.  Felix is surely going to lose a significant amount of his life savings regardless of his decision.  I find it extremely odd that TV commentators and educated bloggers are so willing to take off after one of the victims in this sordid drama.

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