Ethics of strategic default are really hitting home

Some question the morality of homeowners intentionally walking away from mortgages that they can afford to pay

Gail MarksJarvis

Americans have taken a sharp slap in the face from the housing crisis, financial crisis and jobs crisis. Now, some wonder if the residue of those harsh realities is an ethical crisis.

For the first time in the nation's history, bankers say, people are walking away from mortgages they can otherwise afford to pay. The phenomenon known as strategic default was once unthinkable. It represents a calculated decision to hand over the keys to a home without making good on a loan, reasoning that it makes no sense to keep paying the monthly mortgage when the home is worth thousands of dollars less than the obligation.

Jeff Horton, a 33-year-old Orlando, Fla., technology manager, is among those who recently decided to take the step. He told his lender that he's done making payments on the condo he bought in 2005 and the home he bought in 2007, because he wants to move from Florida and can't sell or rent the properties at a price nearly high enough to cover his payments.

"Life is too short," said Horton, who has mortgages totaling about $400,000 with Bank of America — about twice as much as he thinks he would get if he could sell the property. He says he has little choice because the bank has refused to refinance the mortgages or adjust original terms.

Strategic default is a symptom of a housing market that suddenly turned from "American Dream" to financial trap. With the Norman Rockwell-like images of homeownership decimated by a 30 percent plunge in prices, some fear America is also losing its grip on another idyllic notion, that people will live by the slogan: "My word is my bond."

Morgan Stanley recently estimated that about 18 percent of defaults will be strategic. In a recent Pew Research Center survey, 36 percent of Americans said that walking away without paying a mortgage is acceptable, at least under certain circumstances. Fifty-nine percent said the practice is unacceptable.

The saying "My word is my bond" was first posted in the London Stock Exchange in the late 1920s to convey living up to promises. Now, after the worst financial disaster since that period, people such as Horton say they have no such image of Wall Street or large banks as trustworthy institutions, and that has allayed guilt about walking away from mortgages.

"I felt guilty at first," said Horton. "It all stopped when I saw them take $90 million in executive bonuses. They take bailout money and do nothing for the little guy. They wouldn't do anything for me."

Most people walking away from homes see little choice, says John Maddux, chief executive of UWalkAway, a Web site that provides advice on the strategic-default process. "They bought the house thinking of it as an investment in their future," he said. "For some, it was to be their retirement; for others, it was seen as forced savings, and now it's bleeding them dry."

Overburdened with mortgages, people conclude they won't be able to send their children to college, save anything for retirement or move to a place where they can find a job. But as they go through the soul-searching and guilt connected with walking away, Maddux noted they often point to a sense of betrayal.

He said he frequently hears: "I don't feel bad for the banks. They let this happen. Banks made the mistake of giving a loan to anyone if they had a pulse. Their loose lending standard led to a bubble, and the regulators should have controlled this."

Banking expert E. Philip Davis sympathizes with that point of view, but he also points out the implication of homeowners walking away from a commitment.

"It makes them as bad as the bankers," said Davis, a Baptist minister in the United Kingdom who teaches courses on fostering stability in the financial system.

The erosion of the ethic of keeping promises "will be a cancer for society," said Davis, who was with the Bank of England and is now a fellow at the U.K.'s National Institute of Economic and Social Research.

On the surface, one consequence is evident: If bankers don't trust that people will pay off their loans, banks will demand higher interest and other assurances before lending in the future.

In fact, there's research behind the concern, says Tom Donaldson, a University of Pennsylvania Wharton business ethics professor. And it shows that both bankers and borrowers are at risk if trust erodes.

"We've known for decades that trust is critical to successful business," said Donaldson. "Studies have shown that if one party cheats on one end, the other party feels more entitled to cheat. It's not the most noble way, but it is human nature and it becomes a race to the bottom."

Research into strategic default by University of Chicago Booth School of Business professor Luigi Zingales shows what he calls "the contagion effect." "The stigma goes down once you see someone else do it," he said.

Donaldson adds, "I hope bankers are thinking about restoring trust. It's enormously in their interest."

Jim Wallis, the author of "Rediscovering Values: On Wall Street, Main Street and Your Street," is discouraged. He had hoped that the financial crisis would lead individuals and business leaders to seek what he calls "a moral recovery," and deal with issues such as "enough is enough" and "we're in it together."

But while he saw interest from businesses at the Davos World Economic Forum after the financial meltdown in 2008, he said the focus has shifted. Now he sees a lot of "anger and yelling" by individuals, and occasionally business people approach him to "voice frustration and yearning. There is no champion for a values discussion."

While Wallis tries to get individuals to question whether individual debt levels were a moral breach leading up to the financial crisis, others say people now have an ethical duty to their families to walk away from debts if paying mortgages would hurt their financial stability.

Brent White, a University of Arizona law professor, argued in a recent paper that people have a moral obligation to their families to move on from mortgages that will overburden them. He said mortgages are legal contracts written with the understanding that they might be breached.

Those agreements stipulate what will occur if a borrower does not make payments as required. The borrower must turn the collateral, or home, back to the bank, and when that is done the contract is fulfilled.

Historically, taking back homes was a satisfactory remedy for banks. But that is no longer true, because both individuals and banks find themselves in the abyss of the housing crisis. Some homeowners can't afford their mortgages, while banks are struggling to manage the record number of foreclosures.

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