In my 2010 financial market predictions, I predicted that strategic defaults (e.g. a homeowner stops making mortgage payments even though they can afford the payments, but feel they have made a bad investment) would be a small trend that continued to gain momentum.

Follow up data from PBS Newshour suggests this prediction has been proven correct. However, the interesting thing, at least from my interest in social psychology and business ethics, it would appear that everyone is predictably clinging to the “me first” or “continuance of the morality double standard” mentalities.

The Banker

When you make a promise to pay or a promise to do anything you have an obligation, a moral obligation, to stand by your word. — Bill Valenti

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Not surprisingly, the banker’s personal interests (e.g. the borrower should always pay regardless if the investment is in the black or in the red) line up with his business interests (e.g. not losing money). In the business world, this is not the way things are done.

Investment bank Morgan Stanley walked away / strategically defaulted on five San Francisco properties worth $2 billion dollars bought at the peak of the real estate bubble, real estate investment corporations Macerich, Vornado Realty Trust and Simon Property Group all strategically defaulted when their properties were underwater, and even entities like the Mortgage Bankers Association have strategically defaulted — an organization that should act as the beacon of borrower responsibility since they tout the moral obligation of always paying your mortgage — but decided to pull out when staying in their underwater property was no longer in their best financial interest.

So to suggest that a private citizen can’t act similarly is a double standard at best, and  hypocritical at its worst, after you preach one set of rules to masses, yet construct an entirely different set of rules that allow for certain perks for yourself and your cohort.

Indeed, membership has its privileges.

The Economist

In commercial real estate, it is explicitly said in the contract that I [the business man] have the option to walk away. And so walking away is part of the contract; there is nothing strange, illegal, or immoral as far as I’m concerned because both parties understood that clearly. — Luigi Zingales

What Dr. Zingales neglects to mention is that nonrecourse clauses can be added to residential loans very easily by including a few lines of text, but are purposely omitted for the express purpose of applying leverage upon the borrower to “convince” borrowers to pay their bills (e.g. pay your bill or hold you personally responsible and we trash your credit).

For those unfamiliar with nonrecourse loans:

Nonrecourse debt or a nonrecourse loan is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender’s recovery is limited to the collateral. — Wikipedia

By excluding this very simple, easy to be included contractual language, as is typically done in commercial real estate and the owner financing market (where property owners cut out the banking middlemen and, in effect, become the bank and accept monthly payments plus interest from the occupant), banks can maintain a form of control over the homeowner.

In other words, it’s simple leverage. If the borrower doesn’t pay up, the lender not only forecloses on the property, but also holds them personally responsible for defaulting on the debt. In some states, the banks have so much power that they can seize a strategic defaulter’s remaining assets (a second home, cash holdings, equity or bond investments, etc.) in an attempt to recoup lost funds from the transaction.

The Legal Professor

As to whether society would fall apart if individuals acted in their own economic self interests…  it’s ironic that in a capitalist society, we say that if people act like capitalists that society will fall apart.

We expect corporations to act in their economic best interests because that is economically efficient, it’s supposed to least to optimal results. So why is it that when individuals do the exactly same thing, it’s supposed to lead to the destruction of our capitalist society.

- Law Professor Brent White

The application of the morality standard doesn’t get more obvious than this. However, the social stigma of foreclosure does appear to be on the decline (e.g. easier to feel at ease when there are greater numbers).

Moreover, if you’re more cynically minded, herein lies one of the major problems with current American culture at large and the institution of Too Big To Fail banking: all of us are equal, but some of us are more equal than others.

Meaning, using a little George Orwell Animal Farm logic, that what’s good for some is good for others, but it can be better for a select few if they selectively engineer a system where the majority doesn’t get to play by a less strict and more forgiving set of rules.

In other words, hypocrisy pays. And it pays well.

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Hat tip to Paul Solman for providing the meat of this blog post with his video interviews.