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What is Your Obligation to Your Lender?

March 25th, 2008

Initially I was going to include this in the next issue of “Comments on Comments,” but it’s awfully long, and despite having recently posted a handful of thought-provoking posts (at least, IMO) in the last week or so, the comments have been few and far between. I didn’t want to let this wait any longer.

I really must have a pushed one of Logan‘s buttons when (in #10)I said:

It is perfectly within the realm of accepted behavior to forfeit one’s collateral to the lender when one is unwilling or unable to continue servicing the debt as scheduled

He left a lengthy comment, the crux of which is: “No, it’s not acceptable to forfeit the collateral,” and that it’s morally wrong to do so, especially e.g., “to sidestep the lender by buying another property just to avoid being in a negative equity situation in the original property.”

Further, he’s conflating my arguments, and although I appreciate feedback, I think his enthusiasm is misplaced. I never suggested that someone should play musical chairs with his mortgages. What I suggested is that you should get into a new home and default on the old one, if you anticipate being unable to make the payments. Logan explains that you can get positive equity by paying down your mortgage, but I think my position has gone over his head: if you can’t afford your mortgage payment, you certainly can’t afford to pay it down!

The bank is going to end up with the property anyways, so you might as well get out and in to something you can afford, if you can afford it. To be sure, there are very few circumstances under which this would even be possible given the current market conditions.

Let me make one thing abundantly clear: I’m not talking about people who are trying to dump a property that they can easily afford, just because they’re upside-down. That would be financial suicide, and Logan should know better than that. If you can afford to make your payments, you should just weather the storm. If you have the financial wherewithal to pay down your mortgage, that’s probably the single smartest thing you can do: it’s a guaranteed return on your investment of 6 or 7%.

He proceeds with a fictional diatribe as spoken by the defaultor to the lender:

I’m going to stick you with a piece of property that I know you never wanted, that I know you hoped to never have to ever deal with, and that I know you only wrote in the note as collateral for contingency purposes should I default on the terms of our mutual agreement…

I hope you now realize, Mr. Lender, that my word is no good, my signature is meaningless, I’m acting in bad faith, and even though you fulfilled your obligation to me by lending me the money to buy the property I now say unto you: SCREW YOU!

It’s important to note that none of the banks really had to raise the capital! On top of loaning out other people’s money, the rest of it, they conjured it out of thin fucking air, with the help of their friends at the Federal Reserve.

Logan is acting like a bank-apologist, which is ultimately a state-apologist. Probably more people should be telling the banks where to go. It’s not like the banks did nothing wrong during the last half-decade! Lots of people who don’t know better were sold sketchy loans by people who do (or ought to) know better. And lots of otherwise good people took on shady loans from otherwise good brokers and lenders because they all thought the housing boom would last forever.

Perhaps the borrower is saying something like,

I’m giving you this property that I know you never wanted, because you’re sticking me with an interest rate and payment schedule that you know I never wanted, and that furthermore, you should have known I could not afford. I only accepted the terms of your contract of adhesion because I thought I’d never have to deal with those contingencies, just like you thought you’d never have to deal with my default. The only reason I bought the house is because you, dear lender, approved me for the loan. You told me I could afford it. (And if you hadn’t, someone else would have). We both erred. Now it’s your turn to deal with this property, and my turn to deal with a severely damaged credit rating.

Of course, it was expressed in the contract that there would be no guarantee of refinancing on favorable terms (or any terms, for that matter) but the implication was certainly that financing was and always would be indefinitely available. Even if the banks did not say so, it had to be so, in-fact, because the house-of-cards upon which fractional reserve banking is built relies on the perpetual augmentation of the monetary base.

He continues,

Such behavior does not follow the Golden Rule, which we all learned from preschool onward as the basic foundation of human decency.

Are the bankers to follow this Rule, too? This is not an unimportant question, what with the foundation of human decency and all!

I mean, “Hey, let’s make riskless profit off the backs of people who don’t know any better! Let’s profit from monetary inflation!”

Logan, I shouldn’t have to tell you: that’s not much of a rallying cry.

Comments

3 Comments

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  • olly says on: March 25, 2008 at 12:05 pm

     

    I guess I just don’t understand the confusion here. If you signed a contract that said “if I can’t afford to pay X then I’ll give you this collateral” then what’s wrong with saying “well, can’t afford it, here you go.”

    Why would this be immoral — it’s what was agreed upon mutually up front?

    If the bank didn’t want the collateral in the first place then they shouldn’t have signed an agreement to take it on in case of default — so in the end, if the bank makes the dumbfuck move of agreeing to take on collateral that they don’t want… maybe they’ll learn not to be morons about lending in the future!

    Everyone is to blame for this crisis — the government and the stupid fed are of course to blame, both for their subsidy of the behavior that led to it and their moral bankruptcy in robbing the rest of us blind to try to stem the bleeding after the fact — lenders are to blame for being idiots about who and how they lend money out, and then whining about defaults later on — and Joe Q. Public is to blame for taking on a monthly debt that he/she can’t afford.

    But even given all of that, if someone wants to bow out of their loan, and are doing so in a way that fulfills their contractual obligations… well, cry me a fucking river Mr. Bank.

    -olly

  • Logan Flatt, CFA says on: March 28, 2008 at 10:59 pm

     

    David,

    I encourage you to re-read my original post without emotion. I clearly was not talking about people who can no longer afford their mortgage payments; I was talking about people who can afford their mortgage payments but because they are in a negative equity situation freely choose to abandon their promise to a lender (not necessarily a bank, by the way) and borrow again to buy another property and simply walk away from the first property.

    I am not a “bank-apologist” or “state-apologist”, but I am a lender myself. Lending and borrowing are a natural part of capitalism, if not a defining part of capitalism. A lender uses money (the principal) to make more money (the interest and fees). Similarly, an investor uses money (the investment) to make more money (the dividends/royalties/rental fees, etc.). There is nothing inherently evil in these two types of capitalist activity; but, there can be evil in how human beings and organizations of human beings behave in such capitalist activity. And such evil can show up on both sides of the transaction. All I was trying to point out in my original post was that evil does lurk in the hearts of borrowers as well. The property leaping by a healthy borrower done to avoid TEMPORARY negative equity is a great example.

    Logan.

  • olly says on: April 9, 2008 at 8:25 am

     

    Logan — I’m not sure I even think there is a problem with someone voluntarily walking away from something that they can afford just because they are in a negative equity situation. I know that David has previously stated that he DOES see a problem with this — however, my feeling is that any lender (bank or otherwise) takes on the risk of default when they lend out money. Whether that default is because of the loan recipient’s inability to pay the loan back, or simply them defaulting by choice, in the end is frankly irrelevant in my view.

    Any lending contract is written (or at least should be if the lender is at all savvy) with clauses that satisfy them in the case of default. If I, as the loan recipient, decide that I no longer want to be a part of that contract –for any reason whatsoever– then there are obligations that I must fulfill to exit the contract.

    Again, I must return to the fact that if the lender knowingly entered into a contract where the obligations placed on the loan recipient in case of default were not satisfactory, then the lender entered themselves into a bad contract, plain and simple.

    If I lend my best friend $1000.00, with the clause that if he doesn’t pay me back then I get ownership of his snowmobile, and he decides that it’s more worth it to him to give me the snowmobile then to pay back the $1000.00, well, isn’t he still fulfilling his contractual obligations? Again, we agreed to this ahead of time, so what right do I have to get angry with him about it? Sure, I might think twice about future contractual agreements with him, given that he’s already defaulted once, but in the end if I agreed on it, it’s a done deal.

    Now, if we made the same agreement and then he refused to pay me back the $1000.00 OR give me the snowmobile, then he’d be in breach of contract, and in that sense acting immorally.

    As an anarchist, this is what it comes down to for me — if a contract is entered into in good faith (in other words without coercion) by both parties, and that contract is fulfilled, then there is no room for either party to complain. As long as the lender is getting the collateral they signed off on in the first place, then the loan recipient has done nothing wrong.

    -olly

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