Saturday, December 19, 2009

Still walking away

In a story that began at least two years ago, from the retail crowd anyway, the debate continues about those willing to walk away from their submerged mortgages.

In the latest WSJ article on the subject, the action was characterized as the Debtor's Dilemma: Pay the Mortgage or Walk Away . It summarizes the story with:
In Down Real-Estate Market, Homeowners Are Deciding to Abandon Their Loan Obligations Even if They Can Afford the Payments

A growing number of people in Arizona, California, Florida and Nevada, where home prices have plunged, are considering what is known as a "strategic default," walking away from their mortgages not out of necessity but because they believe it is in their best financial interests.

George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay -- and weren't deceived by the lender about the nature of the loan -- have a moral responsibility to keep paying. It would be disastrous for the economy if Americans concluded they were free to walk away from such commitments, he says.

Steve Waldman's most recent two posts visit the debate in his worthy Interfluidity blog, here and here.

His take in Strategic default and the duty to shareholders:
Businesses walk away from contracts all the time, whenever the benefits of doing so exceed the costs under the terms by which they are bound. McArdle is certainly right to point out that companies frequently honor costly bargains they could get away with breaking, because their reputations would be harmed by walking away. But, reputational costs are economic costs. They are a part of the cost/benefit analysis that firms use in making decisions. It is not virtue that binds them to keep their word, but medium-term self-interest. Similarly, homeowners consider the hit to their credit rating and potential loss of social standing prior to walking away.

The question is whether debtors should keep paying off loans simply because it is the “right thing to do”, even when, taking all financial and non-financial costs into account, they would be better off reneging. A human being can choose to be “upright” in this way, if she wants. But under the prevailing norms of business, managers of all but the smallest firms can not so choose.

In practical terms, exhortations to individuals that cannot apply to firms leave us with what Felix Salmon aptly describes as “the world’s largest guilt trip“:

The result is a system tilted enormously in favor of institutional lenders who exist in a world of morality-free contracts, and who conspire to lay the world’s largest-ever guilt trip on any borrower who might think about joining them in that world. It’s asymmetrical, it’s unfair… no one would expect a capitalist company to behave in the way that individuals are being told to behave…

And that debate must be made in the context of real life examples, like this one, Morgan Stanley to Give Up 5 San Francisco Towers Bought at Peak (h/t Barry):
Morgan Stanley, the securities firm that spent more than $8 billion on commercial property in 2007, plans to relinquish five San Francisco office buildings to its lender two years after purchasing them from Blackstone Group LP near the top of the market.

“This isn’t a default or foreclosure situation,” Barnes said. “We are going to give them the properties to get out of the loan obligation.”

The San Francisco transfer would mark the second real estate deal to unravel this year for Morgan Stanley, which bet big on the property markets as prices were rising. The firm last month agreed to surrender 17 million square feet of office buildings to Barclays Capital after acquiring them for $6.5 billion in 2007 from Crescent Real Estate Equities.

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