Strengthening Constitutional Self-Government

No Left Turns


The Legal, the Moral, and the Natural

For just about everyone who has addressed the question, the controversy has to do with whether Muslims ought to build a Mosque in the blast-zone of Ground Zero.  Almost everyone agrees with President Obama that the owners of the property have a legal right to build it.  Even so, most people who heard Obama's remarks thought he was endorsing the Mosque, rather than making a trite comment about the legality of the matter.

In this context it is interesting to consider the question of "strategic default"--defaulting on one's mortgage not because one cannot pay it, but rather because it is no longer an economically sound position.  Megan McArdle takes the classic view on the question, saying it is, morally wrong and financially stupid.  The first half of that comment is relevant here.  McArdle believes that a moral man pays his debts.  Failure to pay one's debts when one has the means to do so is a form of fraud, or perhaps theft.  Many Americans, however, don't see it that way.  They simply think that the law allows it, and, therefore, they are perfectly entitled to do it.

I suspect that in both of these cases we are seeing nature at work.  It is natural, and I would say inevitable, for people to conflate what is right with what is legal.  Everyone allows that there is daylight between what is right and what the law allows or requires.  On the other hand, to hold that the legal and the moral are completely separable is to wish for that which cannot happen among men.  The law is by nature a moral teacher.  It cannot be otherwise so long as we remain human.

Categories > Education

Discussions - 9 Comments

Are strategic defaults addressed in the Constitution?

The analogy strikes me as really weak.

Actually a large part of Megan McArdle's argument is that in lots of cases there are plenty of fees and costs associated with defaulting, and your credit rating will be destroyed for years. Some states already have laws that allow mortgage-lenders to go after the assets of borrowers.

If the practice was widespread enough Congress would write better laws, and contrary to Megan's assertion that this would cost everyone more it would actually cost us less. (states with such laws allow mortgage-lenders to offer lower rates, since they don't need to spread the loss if they can go after other assets.)

Second, Megan says, it is morally wrong to walk away, because your mortgage represented "a promise to pay." If everyone entered into a mortgage with a secret plan to walk away if the house value falls, Congress would write new laws allowing mortgage-lenders to go after borrowers' other assets (which already exist in some states).

Thus I think as long as Megan wants to write from a sort of utilitarian/prudential basis she should encourage both skepticism in regards the idea that there is a "strategic default"(there are costs), but if it turns out to be strategic then she should encourage it. That is Megan should encourage "strategic morgage default" in cases where it may make sense.

The whole idea of doing the moral thing, just results in resentment. That is folks who should "strategically default" are held back by a moral sentiment. Being held back by moral sentiment simply results in things never getting bad enough to force congress to pass better laws. In some sense you could ironically argue that it is your civic duty to strategically default. It is only by exploiting loopholes that congress closes them.

On the other hand the idea that there is a difference between morality and what the law is or requires is widespread and somewhat of a luxury. In this sense the value of your moral stance must be greater than the margin between the legal burden and the strategic bennefit.

But when you factor in the widespread moral objection to strategic default you get to a place with current laws(assuming you are in a state where mortgage lenders can't go after other assets) where there just isn't the impetus to change the law. Now this doesn't mean that some folks won't strategically default, but simply that not enough will so that enough pressure will be put on the law to change. So this morality in effect provides a free-ride and ensures a gap remains where "strategic default" isn't simply theoretical.

It is actually Megan's moral plea that is responsible for "strategic default". You probably have a civic duty to exploit any and all possible legal loop holes. It is only by exploiting them that you provide the political will to close the loop holes.

Contrary to what Megan says it isn't the person who exploits "strategic default" who is really responsible for everyone paying more (albeit this will be the proximate cause and short-run consequence). It is rather the stale mate between the moral stance and the "strategic default" group that creates a market equilibrium in congress that is bellow the necessary threshold required to adopt laws a minority of states have that permit going after the other assets of borrowers.

In other words Megan's argument that it is financially stupid is actually interesting...if it really is financially stupid then there is hardly such a thing as "strategic default" which also means that the law is what it should be.

But notice that States that don't allow morgage lenders to go after additional assets, are really depending on Megan's moral sense to subsidize those who follow the letter of the law. This does result in higher prices for everyone, but only in these states.(not exactly, since countrywide(now BAC) and many others are nationwide.)

I think as a general rule policy shouldn't be designed in such a way that folks who do the right thing end up being victims. Whenever you have a spot where you have to resort to moral exortation you have failed as a policymaker. I think the right answer is to consult a CPA or a lawyer and if this "strategic default" is a reality and not simply an overhyped hypothetical you should act on it.

As a citizen it isn't your job to do the moral thing if it can only serve to mask the policy mistakes of politicians, and it certainly isn't your job to participate in some sort of natural stalemate where your moral standards mark your victimhood status. Megan McArdle's argument further serves to undermine the credibility of capitalism and the public trust that wealth represents productivity, by ingraning the sense that moral behavior and poverty are compliments.

Doesn't the premise that "it is a civic duty to exploit loopholes" lend itself to all kinds of possible theoretical scenarios? If there were no laws on the books re: murder, would I have a "civic duty" to murder?

The example is hyperbolic to prove a point, but I do think you get into gray areas where your suggestion is not so benign. Strategic defaults are one thing.

Owl if there were no laws on the books, there would be no civic duty.

Also it seems to me that laws against murder are most basic.

Maybe if you are Rousseau you can think of a society that might neglect to have laws against murder and never feel the lack. Interestingly enough Rousseau wrote a constitution for Corsica(theoretic not actually addopted.) Rousseau says: "There are peoples who, do what you may, are incapable of being well governed, for the law has no hold over them, and a government without laws cannot be a good government." This is interesting in terms of murder because Corsica originated the Vendetta, where you are obligated by honor to kill those who wrong your familly honor.

Rousseau started out by instructing the Corsicans in agriculture, apparently forgetting that Cain was a farmer. (I joke) But the Genesis account shared by Islam, Christianity and Judaism all manage to get murder out of the way early.

In terms of murder perhaps the vikings are most interesting in the way they make it a question not of criminal law but of tort law. That is if you killed someone the familly could collect wealth for the lost labor weregild.

It seems to me that murder might be easily foreseeable and covered by a law giver. supposing you lived in a society where there were very few rules and murder was not one of them then if you killed someone odds are something like the banishment of Cain, the weregild of the Vikings or the Vendetta of the Corsicans might ensue. It is even possible that murderers were the founders of civilization, as a murder brought together people who sided either with the victim or the stronger killer. Perhaps the murderer created a civil society where it was okay to kill helots(farmers for the spartans). It wasn't till after a murder occured that it was justified, rationalized and rules against it promulgated for those who shared a civil society and thus a common civic duty.

I was really thinking more narrowly about civic duty. I don't think congress or state legistlatures are really all that active on issues until they have festered for a while. In fact we don't even really know the extent of strategic defaults. All I know is that in some states they are more or less impossible, while in other states they seem a plausible idea.

Also if you bought a house during the boom you did so in part with the expecation fueled by the realtor that its valuation would continue to increase. Like growth stocks that can sustain a higher P.E. real estate during a boom can sustain a higher P.R. (price to rents) When home prices fall what really falls is the multiple or PR, you paid in some sense for inflated future expectations, so you paid for an eventuality that did not occur. Whoever sold the house captured future rents that did not materialize.

If your morgage is 200k and your home is currently worth 100k your initial investment if under 100k is gone, but assuming you lost 50k and are currently upsidedown 50k then the morgage company would only eat 50k on a strategic default(in states where they cold go after other assets they could probably get everything back.) It is possible that consumer protection laws want you to be able to default. The stronger the consumer protection laws the more you pay in interest rates anyways.

What is the justification for interest in the first place? (under Sharia and early forms of christianity it was frowned upon) but in capitalist systems it is a reward necessary for taking on risk. A bird in the hand is worth 2 in the bush. If I am going to loan out my bird I need a promise that I will get more birds in return. If 51 times out of 100 when I loan my bird out with the promise to have 2 returned, the deal is completed then I end up with 102 and I write the 49 times off as a loss. 100% interest becomes 2%, what seems like usery is very modest gain. When the same entrepreneurs return perhaps with regard to the 51 2 birds in the hand are worth 3 in the bush and with regard to the 49 1 bird in the hand is worth 3 in the bush.

Interest rates and capital requirements(down payments) are set to take into account default. In good times the Capitalist mints a fortune off the back of labor, other capitalist in competition to secure favorable loans to these successful laborers come in and offer lower rates, perhaps the government even decides that home ownership is a fundamental component of the american dream and seeks to subsidize the loans, money becomes too cheap since risk is undervalued and the capitalists or GSE(in the case of Fannie and Freddie) take massive loss on the chin.

Capital requirements or down payments are really what you owe, and in cases where you strategically default you take this on the chin and share the pain of your capitalist. But the banks are already receiving consideration in the form of interest and downpayments for the contingency that might come up where strategic default is a possibility.

That is why you are paying interest, I certainly suppose that a moral man pays his debts, but a moral lender does not charge interest(or usery). According to Sharia you cannot charge interest on a loan to a muslim, but you can do so to an infidel. The reason being that the infidel is not a moral man.

Your FICO score that the Bank keeps replaces St Peter and is more or less a measure of morality according to the Capitalist. Strategic default is immoral in the eyes of your bank, but default in general is also immoral. You will end up having to promise more future birds in the bush for the one in the hand. It isn't really immoral to strategically default on the bank, but neither is it altogether immoral for a bank to charge one person 5% and another 14% for the same loan.

Almost all consumer protection type legistlation(not allowing banks to go after assets other than your house) ends up costing you higher interest rates that you invariably pay for. The bank will require a higher downpayment, a stronger work history, higher margins between the fed rate and interest rate. When you sit down and sign your morgage there is no risk in your loan that the bank hasn't already baked in. (except in periods when the fed gov pumps money into housing and the fed keeps rates artificially low, and banks are competing to underprice risk)

In consideration for the bank loan you give interest, and to protect the bank against a market downturn you must put up a downpayment. I am not at all sure that there is room left for saying you owe a moral commitment. Perhaps if it was a christian savings and loan or a Muslim savings and loan and in consideration for a lower interest rate and or downpayment you proclaimed your faith and they thus had a reliance interest in your moral character.

As it is it seems fitting that the bank absorb loss for its miscalculation in giving you a loan, certainly with a downpayment you will also absorb a loss. The seller will have booked a heafty profit on a potential future scenario that inflated the PR(price to rents) of the home, while you the strategically defaulting buyer will have lost your principal, your credit rating, but in exchange the bank shares in the upsidedown portion of the suffering. In an alternate world, had you paid the loan to maturity the bank would have made a considerable profit, your home would have continued to appreaciate(as you envisioned it would, when in reliance upon this you stepped up to the plate and purchased it.)

In addition it is difficult to say that if you bought the house under certain laws(reliances and expectations) that set the parameters for the contract that you aren't fully entitled to the consumer protections you paid for.

A contract is any promise or set of promises made by one party to another for the breach of which the law provides a remedy.

Suppose that your bank was a christian or muslim savings and loans that charged marginal interest and didn't require a downpayment. I think that given such reliance upon your moral fiber you would have a duty to repay. Not doing so when you could do so would be fraud or theft, because such potential assumptions about your character would never be baked into the equation.

I think if you want to bring in Muslims to this discussion, you hold that sometimes it would be okay for american courts to uphold sharia law at least in arbitration or contract cases where both parties are muslim and have made a deal in reliance upon a certain religious premises. I also think it is okay for folks to bind themselves in a more strict catholic or muslim marriage that might rule out abortion or make divorce extremely difficult.

But the bank is using FICO and economic projections from Moodys S&P and Case-Shiller, the banks in 2006 had the same high expectations of profit margins as the poor guy who is contemplating loosing his principal but getting out of being upsidedown by strategic default. The banks are both more knowledgeable about contracts, and more knowledgeable(or have a greater responsibility to be so) about the economic picture than the person who entered into the bad loan. Furthermore the terms of the contract written by the bank already included the legal possibility of strategic default (but this was discounted because like the poor upsidedown home owner the bank didn't expect such a large move to the downside.)

A contract is any promise or set of promises made by one party to another for the breach of which the law provides a remedy. The promise includes a knowledge of the consequences of a breach(especially on the side of the bank). If you strategicaly default all you are doing is chosing breach. There is nothing wrong with choosing breach since this was part of the contract and priced into the contract. If you lived in a state with greater consumer protections you paid more in interest and downpayment (because banks could not go after other assets). In the housing bubble banks misspriced this state by state consumer protection legal environment because they assumed that any downturn would be a minor blimp and covered by downpayments. Even if this is the case this reliance interest on the part of big banks should not have a restraining effect since your reliance was partially based upon their authority and reliance. That is both parties shared in a similar reliance, and of the two parties large banks should have known better.

It is perfectly acceptable to breach if you prefer the consequences of breach to the consequences of non-breach.

After a couple long rants I decided to dig into the law a bit... as I suspected Bush is to blame:)

That isn't totally fair but a lot of the housing bubble did follow from his commitment to the ownership society, strangely enough off the bat you would say that a conservative policy might favor less consumer protection for folks that choose to strategically default.
Of course you have a federalism issue as well. We don't necessarily want the federal government to pre-empt the state legistlatures on this one.

But little did I realize that it really is a sort of case where republicans bend what might otherwise be a principled conservative position to suit the upper middle class (after all these are the ones most shielded by preventing morgage lenders from going after other assets) When a member of the lower middle class looses a home, they lose almost everything anyways, the upper middle class and the rich on the other hand are those for whom strategic default begins to make more sense. I mean a lot of middle class and lower middle class weren't diversified enough to be able to loose a house and still have easily targetable assets.

What amazed me was the Mortgage Forgiveness Debt Relief Act of 2007 " So I'm working with members of both parties to pass a bill that will protect homeowners from having to pay taxes on cancelled mortgage debt."

In my old 200k example (most strategic are in 300k and above) someone with an underwater morgage would lose 50k equity and the bank would lose 50k equity, when the house was sold for 100k.

In this case the strategic morgage default would get you 50k, which would be considered income and become taxable. I was thinking of these taxes along with the barriers to new morgages (3+7 years depending) along with the hit to the credit score(and only in states where they couldn't seize other assets...thinking it was probably overblown....

But while you would otherwise have to pay taxes on the amount forgiven in a strategic morgage default, thanks to George Bush and congress in 2007 and the Obama team and congress extending it to 2012(and beyond)...this does not and will not count as Income.

So basically Congress is saying: we know that traditionally the role of the IRS is to raise taxes to fund government, but look deficits don't matter(Cheney) forget talk about expanding the tax base, CBO, et al...we are going to subsidize strategic default by not taxing it as income.

Can we just agree on a couple of pretty-obvious points, please?

1. Those opposed to this mosque are really showing their opposition to the religion of Islam, not the sensitivity of the Islamic center's location (which isn't at Ground Zero) or the group behind it (both Beck and Ingraham have offered approval of the work of Rauf and his wife before). There is no such thing as far enough from the 9/11 WTC Ground Zero as to qualify as "sensitive" since the opposition is really about Islam, not the Al Qaeda terrorists. Case in point:

"MURFREESBORO, Tenn. -- The fight isn't over regarding the plans to build a new mosque in Murfreesboro.

Opponents of the plans told Channel 4's news partners at the Daily News Journal they're planning a protest march the afternoon of July 14.

The group plans to start at Central Magnet School and march to the courthouse to drop off petitions against the new Islamic Center.

Lou Ann Zelenik, Tennessee Republican candidate for Congress, recently issued a statement that plans to build a mosque in Murfreesboro pose a threat to the state's moral and political foundation.

Plans for the new 52,000-square-foot mosque on Veals Road have already been approved."

2. If the Cordoba/Park 51 Islamic Ctr. is built in the planned location, the odds of it or its Islamic membership being attacked are probably a great deal higher than any terrorist plotting being discovered, ever. Case in point:

"Ben Goodwin of the Rutherford County Sheriff's Department confirmed to CBS Affiliate WTVF that the fire, which burned construction equipment at the future site of the Islamic Center of Murfreesboro, is being ruled as arson.

Special Agent Andy Anderson of the federal Bureau of Alcohol, Tobacco, Firearms and Explosives told CBS News that the fire destroyed one piece of construction equipment and damaged three others. Gas was poured over the equipment to start the fire, Anderson said.

Opponents of a new Islamic center say they believe the mosque will be more than a place of prayer; they are afraid the 15-acre site that was once farmland will be turned into a terrorist training ground for Muslim militants bent on overthrowing the U.S. government.

"They are not a religion. They are a political, militaristic group," Bob Shelton, a 76-year-old retiree who lives in the area, told The Associated Press.

Shelton was among several hundred demonstrators who recently wore "Vote for Jesus" T-shirts and carried signs that said "No Sharia law for USA!," referring to the Islamic code of law.

Others took their opposition further, spray painting a sign announcing the "Future site of the Islamic Center of Murfreesboro" and tearing it up.

Earlier this summer opponents criticized the planned mosque at hearings held by the Rutherford County Commission, as supporters held prayer vigils.

At one such prayer vigil, WTVF reported opponents speaking out against construction.

"No mosque in Murfreesboro. I don't want it. I don't want them here," Evy Summers said to WTVF. "Go start their own country overseas somewhere. This is a Christian country. It was based on Christianity." "

Sounds familiar to me.

Clarification: I meant to write, for point #2 above "the odds of it or its Islamic membership being attacked are probably a great deal higher than any terrorist plotting being discovered AT THAT CENTER, ever.

Oh, and big surprise, that minor religious figure that nobody pays attention to - Pat Robertson - found it necessary to weigh in on the Tennessee mosque/center:

We are conducting a survey on a number of the leading political and constitutional issues of the day. Issues discussed in our survey include abortion, gay marriage and gun rights. You are invited to take part in this survey. As an added incentive, we will pay a $100, a $50, and five $10 bonuses to randomly selected respondents at the conclusion of the survey. The link is here:

This is fun:

I also note that the phrase (from the orig. blog post) "the blast-zone of Ground Zero" sounds odd - I thought that was one used by inside-job conspiracy theorists??

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