debt

by russell

I was interested in finding out about student loan debt in the US.  It's huge now, larger than credit card debt.  Lots of young folks are starting out their professional lives tens (or more) of thousands of dollars in the hole.

Yikes.

While looking around on that topic, I ran across this bit of advice on how to address student loan obligations:

You want my advice? Having your student debts go into default is survivable.

In other words, default.  Walk away.  It will suck, but not as much as living with the weight of the loan obligation.

This made me think of my sister and brother in law, who, after 40 years of productive work life, are deliberately going bankrupt.  They live in Phoenix, they took a ridiculous bath on the value of their house, they had some medical things come up, and they got so far behind that, at 60+ years of age, the simple math said they were never going to get on the good side of it.

So they're going bankrupt.  And, they're not losing any sleep over it.

Likewise, my niece and her husband are jingle-mail veterans.  They bought a nice house in Gilbert AZ, then they had twin girls and my niece couldn't work as many hours, then her husband's work got thin.  And they couldn't make the mortgage.

So they walked away.  Period.  Packed up, rented an apartment, and mailed in the keys.  Sayonara.

Walking away from debt obligations has become a reasonable and perfectly acceptable option, for millions of normal middle class working folks.  I am quite certain that most folks reading this know, from their own lives, examples of folks doing this.  I am quite certain that some number of folks reading this are making that choice, themselves.

What does it mean for our economy, our society, and our culture, that packing it in and walking away from your personal debt obligations has become a reasonable option?

What does it say about the relationship between folks who want and need to make use of credit, and their creditors?

What are the implications going to be, going forward, for folks who walk away from their debts?  And, for the folks who *don't* walk away?  And, for the folks who want to make loans to other people?

To me, this is an example of the fabric of what we have long accepted as normal life, fraying away. 

And, in saying that, I have to say that I find it hard to blame most people who exercise that option.  Financial institutions have almost gone out of their way in recent years to raise a huge middle finger to the rest of the nation.  So, now, folks feel no personal compunction to hold up their end of the bargain, if it's going to wreck their lives to do so.  Which, quite often, it would.

To close, here's a scary picture.  If you think the federal debt load is heavy, the private debt load is much worse

Comments

[Ed Crotty]

When corporations go bankrupt it is seen as a "keen strategic move". When regular people do it, it is seen as some kind of moral failure. Double Standard.

[Tyro]

What does it mean for our economy, our society, and our culture, that packing it in and walking away from your personal debt obligations has become a reasonable option?

It means that lending is a risk, like everything else. There are laws to cover the possibility of default, and these laws form the implicit contract made between borrower and lender.

Bankruptcy exists so that inability to pay debts can be handled as smoothly as possible. Lenders recover what they can, and borrowers don't have to pay what they won't be able to pay.

This is normal and expected. The only unfortunate thing is that education debt isn't dischargeable into bankruptcy, so the consequences of making poor borrowing decisions when it comes to your education are much worse than making poor borrowing decisions when buying a house, car, or starting a business.

folks feel no personal compunction to hold up their end of the bargain

Bankruptcy or allowing the bank to take possession of the home in event of non-payment is part of the bargain.

[someotherdude]

I got rid of my credit card debt through bankruptcy in 1999.

I never held or used a credit card since.

But my advance degrees are going to kill me.

[avedis]

Bankruptcy is the new revolution for the masses. I'm all for it. Fnck 'em all.

[Grumbles]

Any functional system needs slack. Over optimization inevitably leads to breakdown when something goes wrong.

It looks like we are getting close to that in finance, regulatory capture and energy. And maybe some other things. That is more than a little scary.

[sapient]

For those of us who seek moral guidance from the Judeo-Christian tradition, the Old Testament required discharge of debt every seven years. Usury used to be a significant crime in the bad old days.

It's nothing new that people find themselves enslaved by debt, but more compassionate cultures required occasional relief. I don't think bankruptcy (or default in the case of nondischargable loans) is immoral. It's certainly not the optimal situation for anyone, and I feel bad for anyone who has that kind of stress in their lives.

[DecidedFenceSitter]

What does it mean? Credit is going to be reduced because lenders are going to realize that it is actually risky.

Or they'll just execute some regulatory capture and ensure it can't be discharged one way or another.

Oh wait they did some of that already if I remember correctly.

For 30 years, we've been using "Have now, purchase later" and well the chickens are coming home to roost; there's only so long a citizen can keep putting things off.

I got to learn my lesson in my college days when I got a credit card, hit the limit (only 500 dollars cause even at 18 I wasn't TOO stupid) and then had to figure out how to pay it off.

As far as the morals of defaulting go? Well you are welcome to apply whatever standard you want, double or not. I, on the other hand, say "It is a contract between two parties that has clauses for what happen if you cease your side of the obligations."

[Brett Bellmore]

And other people watching, who will rightfully not trust you to pay THEM back, if you fail your obligation in this instance.

It certainly is a huge cultural change; I can still recall, fresh out of college in the early 80's, throwing up when I realized I wasn't going to be able to pay all my debts on time. Contracts were morally binding promises. Today I think it's viewed as more some kind of game of musical chairs, with the aim being to have somebody else foot the bill when the music stops.

Of course, back then the whole college experience hadn't been consciously redesigned to involve as much debt as possible, to turn graduates into interest farms. It was quite possible to finance most of your expenses through summer jobs, and pay off your debts within a few years of graduation. This was because the tuition was, for the most part, just paying for your education, not carrying a huge load of non-teaching staff.

The whole system has become some kind of parody of what it used to be.

[CCDG]

I think bankruptcy is a normal part of life, I think that people who walk away from a mortgage when they clearly are not bankrupt is another thing.

Companies don't get to not pay their bills because the last investment they made didn't pan out unless they actually can't pay. To get relief you have to be, well, bankrupt.

And sure, they sometimes do tricky things,but that doesn't change the basic rules or legal obligations.

[CCDG]

"The whole system has become some kind of parody of what it used to be."

Back in the day, if you didnt have the money to go to college you didnt go. While you didnt have debt, you also earned a million dollars less in your career.

College loans used to be something people were ecstatic to get because it meant you were able to go to college.

Now they are a burden, or said another way: Now that I have gotten to go to college I think it should have been free.

Bah.

[sapient]

Tyro is correct that allowing a mortgagee to take possession of a home if a mortgagor defaults is part of the bargain. People can feel a moral impulse as they wish, but creditors lend money in order to make money, and a secured debt is one that a creditor is supposed to not lose money on. That's one reason why the financial industry is so much at fault in the current housing crisis: it's because they made it very profitable in the short term to lend to people whom they basically knew couldn't pay it back. Everyone should have read The Big Short by now, or otherwise learned the story it tells.

I don't feel sorry for secured creditors. If part of your business model is mortgage lending, you ought to know what a home is worth, lend to people who will reasonably be able to pay it back, and then if default comes, turn the property around to get your money. People who walk away from mortgages suffer other consequences from doing so besides just the financial fallout from the house. If the mortgagees made a bad bargain too, because they were ignorant about their own business, too bad for them.

[bobbyp]

What we need is an old fashioned, conservative, morally righteous http://en.wikipedia.org/wiki/Jubilee_(Christianity)>jubilee.

[Slartibartfast]

The whole system has become some kind of parody of what it used to be.

I graduated from college in 1983, and that was right about the time when it became super-easy to acquire a credit card. In 1983 I had a hard time getting a credit card of any kind, but by 1986 or so, it was incredibly easy.

But in 1983, there were still life-insurance agents lining up in the student union to sell pre-graduates policies that they didn't need. Plus ca change.

[someotherdude]

I suspect our access too practically, unlimited credit, has distorted our view of taxes and what the government/state can do better, than what we can do alone with a credit card. (Medical and such)

College education in California was practically free, but as access to credit became easier, college education became more expensive…and our taxes were lowered. And we are more in debt.

[Harald Korneliussen]

In the olden days, when Hilzoy and Publius walked the blog, they would not have missed that Crooked Timber has discussed this topic nearly to death, most recently in a seminar about the book "Debt: the first 5000 years" by David Graeber.

[Ugh]

CCDG: I think bankruptcy is a normal part of life, I think that people who walk away from a mortgage when they clearly are not bankrupt is another thing.

What are you saying here?

I mean, Mortgage Company X loans $150,000 to Person Y to buy a house, upon Y's promise to either (i) repay the loan + interest in cash over some period of time, or (ii) give X the house in discharge of the loan. Later, it turns out that option (ii) works better for Y and he/she chooses that option. What's the problem?

[someotherdude]

Credit Companies have replaced and distorted what we could do better as a community of tax payers...the cult of the individual has made a community of the wealthy even wealthier.

[Snarki, child of Loki]

CCDG:
"Companies don't get to not pay their bills because the last investment they made didn't pan out unless they actually can't pay. To get relief you have to be, well, bankrupt."

Oh, like American Airlines just did, to get out of labor contracts and pension obligations?

When you can hire a bunch of high-price lawyers and accountants, bankruptcy is whatever you want it to be.

[sapient]

bobbyp, I hope the pilgrimage to Rome is part of the Jubilee celebration! I guess we'd have to take turns.

[CCDG]

"Oh, like American Airlines just did, to get out of labor contracts and pension obligations?"

Yes, AA was not going to be able to pay their bills, so they filed Chap 11. They couldn't do that until they were going to be forced to default on their debt. They were, for lack of aa better word, bankrupt.

[CCDG]

"I mean, Mortgage Company X loans $150,000 to Person Y to buy a house, upon Y's promise to either (i) repay the loan + interest in cash over some period of time, or (ii) give X the house in discharge of the loan. Later, it turns out that option (ii) works better for Y and he/she chooses that option. What's the problem?"

The problem is that the promise to pay was backed by collateral, but it was still a promise to pay.

Oddly, in business if you try to do this you often get a huge tax bill which represents the gain between the current value of the asset and the amount you borrowed for it.

Depends on asset type etc. but, more important, you don't get to not pay the difference. Once the asset is sold you get sued for the difference by the creditor because you are NOT bankrupt.

I still don't understand how that doesn't happen in the case of these mortgages when people don't file bankruptcy but just walk away from the mortgage. Other than, of course, the litigation cost makes it not worthwhile.

It should also be noted that in business if thee value of your collateral decreases the creditor often has the right to demand more collateral. All that depends on the credit instrument of course.

But this whole concept that your house is worth less so you have fulfilled your obligation by returning it to the bank, "just like a business does", is pretty much hogwash.

[CCDG]

""I mean, Mortgage Company X loans $150,000 to Person Y to buy a house, upon Y's promise to either (i) repay the loan + interest in cash over some period of time, or (ii) give X the house in discharge of the loan. Later, it turns out that option (ii) works better for Y and he/she chooses that option. What's the problem?""

My view may be better understood if one recognizes that the deal is actually

"I will loan you 150k based on the fact that you have a house that is worth 150k you can put up as collateral".

What you did with the money is irrelevant to the deal. Many mortgages aren't to "buy a house". People often use the value of the house to pay for other things. Many have the ability to pay for the house but choose to use their money for other things.

Oddly, and this is pure anecdotal data, several of the people I know that just walked away from a mortgage were able to do that because they didn't really need credit. They were able to pay the payments but figured out the bank wouldn't sue them for the difference and didn't need credit because of their financial stability. So they got over.

I would suspect that if you really needed credit to get by then it would be harder to decide to do that.

[McKinneyTexas]

Mortgage Company X loans $150,000 to Person Y to buy a house, upon Y's promise to either (i) repay the loan + interest in cash over some period of time, or (ii) give X the house in discharge of the loan. Later, it turns out that option (ii) works better for Y and he/she chooses that option. What's the problem?

This isn't exactly the way it works. The buyer signs a promissory note. The note is secured by a mortgage, which allows the lender to repossess and sell the home. It doesn't stop there. The buyer still owes any difference between any deficiency plus costs of foreclosure.

The credit boom may be our next housing boom/bust. Borrowing money you can't repay is, to me, ethically dubious at best. If we see a mass default at the consumer level, someone takes that hit somewhere and it will not be a plus for the macro-economy.

Bankruptcy may be someone's only and last option. For people like that who are not victim's of their own poor management and lack of self restraint, I empathize. For the others, not so much.

Employers can find out if someone is a bankrupt or a bad credit risk. I won't hire either, normally (there are exceptions). Why? Because I don't like debt collectors calling the office and sending their dun letters to the office, and I don't like, generally, having people around who seem to be fine with borrowing and not repaying money.

The flip side of consumer debt is this: how much of it is principle and how much is interest. I don't lose a lot of sleep over a credit card company not recovering its accumulated 23 or 30 per cent rate of interest. I'd bring back usury laws, even if that meant many, many consumers could no longer get credit, which would likely be the case.

[Rob in CT]

Gah, really long post eated by the internets. Sigh.

Short version: scary amount of debt. Non-dischargeable too, right? Eek.

Tuition/room & board fees are already beyond crazy, and continue to increase. I can think of some reasons: increased % of the pop going to college, supply didn't increase at the same rate, subsidization and particularly loan backing (as opposed to more scholarship money) coupled with decreased state funding (applies to state schools only, obviously), administration eating up more $, more lavish facilities, and in some cases crazy compensation for the top profs (see Lawyers, Guns & Money on that), though prof compensation in general does not look like a major driver to me.

It's all built up over decades and now it's a giant mess. The idea of someone paying their way through college by working summer jobs and at the college bookstore or whatever is now utterly ludicrous.

[Phil]

Now they are a burden, or said another way: Now that I have gotten to go to college I think it should have been free.

There's a rather substantial amount of daylight between "free" and "so comically expensive you'll still be paying it off when you're 60 years old," but if you like the smell of burning straw, so be it.

I'd bring back usury laws,

What kind of conservative are you?!?! Caveat emptor! Capital One has the moral right to make as much profit as it can, even if it's in the form of a 29% APR.

[russell]

In the olden days, when Hilzoy and Publius walked the blog, ...

A la recherche du temps perdu.

Thanks for the link Harald, I had not seen that!

[CCDG]

Phil,

I think the graph that is in your link doesn't assume that the 60 year olds were still paying for college that they attended in their teens or twenties. While I understand that you can end up in substantial debt, the averaage for 20-40 year olds was around 25k at the best interest rates you can get. There is a trillion dollars in student debt because we have been succesful in getting lots of people to go to college.

[liberal japonicus]

CCDG,
not trying to pick on you here, but if you (and everyone else) could try to respond one to one, rather than responding to one comment with multiple comments, I think that would be preferable. I know that feeling one gets after hitting the post button and thinking they should add another point that would more clearly make the point, but it becomes a lot harder to track and respond to arguments as the thread goes on. Thanks

[CCDG]

lj,

I understand your point. Do you have a suggested way of making that further point when one hits enter and realizes that they could provide more clarity on their view? Should one wait for some response and then make the additional point?

[McKinneyTexas]

Capital One has the moral right to make as much profit as it can, even if it's in the form of a 29% APR.

There is a 'freedom of contract' component involved here and almost all of my instincts run counter to protecting adults from their own stupidity (beginning with me: my list of 'stupids' is way bigger than yours. WAY BIGGER!) that cut against usery laws.

That said, there is a limit to which people should be allowed to profit from others' stupidity and poor judgment (or, old age and infirmity--there are buzzards out there who approach elderly seniors and buy their life insurance policies for 10 cents on the dollar. We found out after my dad died that he'd sold the 500K policy on his life for 50K, about 2 years before he died). Moreover, debt collection and bankruptcy impose a real cost on gov't that can and should be mitigated. Maybe we could let a company charge whatever interest rate it wants but allow a legally enforceable debt of only up to 10% interest.

[Tyro]

Contracts were morally binding promises.

But they are not. The reason contracts exist is to create legally binding promises, with the consequences clearly outlined in the event that certain promises cannot be fulfilled. I might argue that there is something morally sketchy about exploiting a loophole in a contract for personal gain, but using a clearly stated part of a contract when making a decision (to declare bankruptcy, default on credit card debt, walk away from a house) isn't an immoral choice. Anyone trying to shame members of the general public by pointing to a supposed "moral" obligation to fulfill a debt to a bank are just trying to exploit the public for personal gain.

[Ugh]

CCDG/McTx - I guess it depends on the terms of the loan. My understanding, which may be wrong, was that the vast majority of first home-loan mortgages (not, e.g., HELOCs) were non-recourse to the borrower. That is, under the terms of the loan, the borrower could turn the house over as full payment for the debt and that was the end of the matter (at least between borrower and lender).

Again, I may be wrong, but if these are the terms of the loan, then I have no idea what anyone is complaining about regarding "walking away."

CCDG is right, of course, that if a lender agrees to accept $50,000 (in cash or in kind) in repayment of a $150,000 loan, the borrower ends up owing tax on the $100,000 difference, absent certain exceptions (such as declaring bankruptcy).

[Tyro]

My understanding, which may be wrong, was that the vast majority of first home-loan mortgages (not, e.g., HELOCs) were non-recourse to the borrower.

This varies by state. And even when the lender can try to go after the borrower's other assets, the lender might decide it isn't worth the trouble.

When starting a business or buying a house, the lender generally demands that the borrower put up some of his own money so that he will have "skin in the game" to provide some incentive to stick with it. But that is part of the lender's risk analysis. The borrower did some of his own risk analysis to determine whether it was worth pursuing in the first place. And sometimes one or both parties are wrong about the risks involved, and one or both parties end up bearing the consequences of that mistaken analysis of the risks. Since banks can disperse their risk widely in a way that individuals can't, when it comes to lending and borrowing, obviously I favor a situation tilted in favor of the borrower.

[Slartibartfast]

The buyer still owes any difference between any deficiency plus costs of foreclosure.

Which is why there is PMI, so the bank doesn't come after you.

But what they don't bother to tell you is that the story doesn't end there: the PMI company is there to protect the bank, not the property owner. The PMI company is free to come after you after foreclosure. And IIRC, they can do that at any time of their choosing after the foreclosure, up to some statute of limitations (7 years? I really cannot recall).

Consider that possibility, and what it might mean for the next XX years of your life.

[evilrooster]

Back in the day, if you didnt have the money to go to college you didnt go. While you didnt have debt, you also earned a million dollars less in your career.

Back in the day, there were also more jobs open to high school graduates. Determining whether the decline is due to the much-lamented decay of the educational system or the increase in college graduates competing for jobs is probably a "Tastes Great/Less Filling" exercise, but there it is.

[Brett Bellmore]

"Contracts were morally binding promises.

But they are not. The reason contracts exist is to create legally binding promises, with the consequences clearly outlined in the event that certain promises cannot be fulfilled."

The legal penalties for rape are on record, too, but that doesn't make committing it moral so long as you accept you're going to prison if they catch you.

When I got out of college, contracts WERE viewed as morally binding promises, and while they might have had penalty clauses, you were still widely viewed as doing something wrong if you violated them.

[someotherdude]

Back in the day, there were also more jobs open to high school graduates.

What happened to those jobs that used to employ those high school graduates? I don't think college grads are competing for, or filling manufacturing jobs.

And using the credit industry for what most Western governments do much better is a recipe for disaster. Loan sharks have become the social safety net.

[John M. Burt]

The global financial system is so out-of-balance that there is a case to be made for a general jubilee.

One form this could take is to simply issue every person $1,000,000 and let them pay off all their debts with hyperinflated dollars.

Or, it could be One Big Bankruptcy, with debts voided one debtor at a time, or one institution at a time.

But yes, a jubilee of some sort.

[evilrooster]

@someotherdude:

What happened to those jobs that used to employ those high school graduates? I don't think college grads are competing for, or filling manufacturing jobs.

Varies. Many manufacturing jobs have gone overseas. But the eye-opener for me, a couple of years ago, was an article on how an increasing proportion of car-rental companies were requiring college degrees for people checking vehicles out to customers. (I can't find the link any more, unfortunately.)

I gather from friends that that's not unusual for low-level white collar jobs. Positions that used to be available to someone with a high school diploma now to want an AA at the very least. It's another way of filtering a flood of resumes for jobs that require literacy and numeracy but not a lot of specialized knowledge or skill.

[sapient]

I don't know how much good it does to compare jobs/qualification/education to the days of yore. The economy has changed so dramatically that a "low level white collar job" of 1970 is not the same as a "low level white collar job" of 2010. And I would argue that most low level white collar jobs in 1970 did require a college education. At least that's my recollection from when I started working in 1978.

The manufacturing jobs have disappeared, which is where I think the high school grads used to find work. They also found it in skilled trades (which are still around, and are still a source of employment, but do require training).

[CCDG]

"Positions that used to be available to someone with a high school diploma now to want an AA at the very least. It's another way of filtering a flood of resumes for jobs that require literacy and numeracy but not a lot of specialized knowledge or skill"

Anecdotally, although I used to have a link for it, I have seen this in hiring for everything from low level white collar jobs to managers in a manufacturing environment.

It also goes to the decline in starting wages for college graduates as they compete for lower level jobs.

[Tyro]

When I got out of college, contracts WERE viewed as morally binding promises, and while they might have had penalty clauses, you were still widely viewed as doing something wrong if you violated them.

I really dispute that this is true. Life is full of countless risks that have nothin to do with your moral standing. Both sides of the contract enter into a certain amount of risk with the assumption that any number of unforeseen events could occur forcing one side or the other to resort to use of the contingency clauses in the contract. No one is being morally violated unless there was some dishonesty or act of bad faith involved.

Your argument doesn't make a lot of sense unless you assume that lending has a sort of morally sacrosanct position not held by any other financial transaction... and if you do, it makes me understand the pre-modern hostility to charging interest.

[Ugh]

Last I checked the U.S. was either #1 or #2 in manufacturing output, depending on the measure. To the extent we're super-productive compared to, e.g., China, I guess that means fewer jobs.

[CCDG]

"No one is being morally violated unless there was some dishonesty or act of bad faith involved."

I would submit that giving the house to the bank when you have the ability to pay is an act of bad faith.

[Ugh]

CCDG: I would submit that giving the house to the bank when you have the ability to pay is an act of bad faith.

Doesn't it depend on the terms of the contract?

[sapient]

Life is full of countless risks that have nothin to do with your moral standing. Both sides of the contract enter into a certain amount of risk with the assumption that any number of unforeseen events could occur forcing one side or the other to resort to use of the contingency clauses in the contract.

I would agree with this. In an arm's length transaction, both people are making a deal based on their interests, financial and otherwise. When the situation is optimal, both parties benefit - person gets to buy a house and pay for it on time, bank makes money via interest on the loan. When things go bad, why should the buyer (mortgagor) be the one who suffers all of the fallout?

Morality has nothing to do with it. Buyer (mortgagor) might be spending that money to buy somebody medical care, or to pay somebody's college loan off, or to donate to the food bank. Or s/he might be going on an expensive vacation. Who knows? We don't, and we can't judge the person's moral character through one business transaction in which the other party (a bank) had good lawyers to see that it was protected.

[bobbyp]

I would submit that giving the house to the bank when you have the ability to pay is an act of bad faith.

I'm shocked. Shocked I say. In a country that worships http://finance.yahoo.com/news/million-dollar-foreclosures-rise-rich-105400917.html>rich people?

[Tyro]

I would submit that giving the house to the bank when you have the ability to pay is an act of bad faith.

Possibly. Or the borrower could use it as leverage to write down some of the principal on favorable terms. I am suspicious of the idea that we should ask someone in an individual-to-bank transaction to behave differently that he would in a bank-to-bank or corporation-to-bank transaction.

In fairness (and I'm a fair guy), one "immoral" example is certainly those with high earning potential who wrote their student loans off into bankruptcy when you were still allowed to do that. Not only was it dishonest, but it ruined it for everyone else when the law was changed because now you CAN'T write your loans off into bankruptcy even if it would be the best decision for everyone involved.

[Phil]

The economy has changed so dramatically that a "low level white collar job" of 1970 is not the same as a "low level white collar job" of 2010.

It probably pays the same, though. /rimshot

[CCDG]

"I am suspicious of the idea that we should ask someone in an individual-to-bank transaction to behave differently that he would in a bank-to-bank or corporation-to-bank transaction."

So I am clear, I don't believe anything I am suggesting is different than B-B or C-B transactions. Except in the business transactions the lender has much more leverage against a company that can pay and chooses not to.

[bobbyp]

Except in the business transactions the lender has much more leverage against a company that can pay and chooses not to.

I recall some old adage to the effect that if you loan a small amount, you have a client, and if you loan a large amount, you have a partner.

Further, a non-recourse loan is just that. Non-recourse. Once the collateral (if there is any) is returned, the obligation is over.

Commercial real estate, which see.

[Ugh]

Contracts, ISTM, are fine between similarly situated parties that have near equal bargaining power and knowledgeable advisers, but even then they get fncked up all the time.

So, I'm not sure why we're supposed to view them as some sort of moral transaction when it's between, say, Wells Fargo and homeowner X.

[CCDG]

"So, I'm not sure why we're supposed to view them as some sort of moral transaction when it's between, say, Wells Fargo and homeowner X."

This is kind of circular :) I understand your point. As a last note, when companies get down to looking at the contract usually one, or both, have already decided the other is not acting in good faith.

They then use the contract as a basis for the next steps. Once you start quoting the contract to each other the weaker player has already lost.

[bobbyp]

As a last note, when companies get down to looking at the contract usually one, or both, have already decided the other is not acting in good faith.

Not true. There are many honest disputes about what is and what is not "in the contract", and it is not a question of 'bad faith'.

cf: Construction contracts.

[hairshirthedonist]

I might be able to see immorality in someone taking out a loan for the purpose of screwing over the lender and lying about his creditworthiness in doing so. I also imagine instances of such are vanishingly few and are currently having a negligible effect on financial markets. (And lenders are supposed to be the experts, the ones who are in the business. They're probably pretty hard to dupe, at least for a typical borrower, though maybe not as an expert agent/middleman who is a creature of moral hazard, preying on lender and borrower alike.)

[bobbyp]

HSH:
heh...when it's other peoples' money, you can securitize everything, and write a CDO on both sides to infinity to boot, who needs due dilligence? Thus doth doing one's homework become an unacceptable business cost.

But we are getting sidetracked. Wherefore art thou, oh fabric of society? Russell's bigger question is going largely unaddressed.

Much is the pity.

[sapient]

What are the implications going to be, going forward, for folks who walk away from their debts? And, for the folks who *don't* walk away? And, for the folks who want to make loans to other people?

Wherefore art thou, oh fabric of society?

This is my feeling as to contracts: If I own an extra house as an investment property, and rent it to a tenant, I enter into a contract (which, to be sensible, I try to do at arm's length), but then I establish a relationship with the tenant, by trying to establish from the get-go that s/he's a responsible person. Then I try to be a responsible person: doing maintenance, keeping in touch, being available.

If I were to become a personal mortgagee of a property, I would take the same approach. I would try to make sure the mortgagor was a responsible person. I would try to make sure that the property was being maintained, and make noise if I felt my collateral was being compromised. I would try to make sure that I would be covered by the value of the house if I had to sell it.

But if the economy went bad, and the real estate market tanked, I would expect the possibility that everybody miscalculated, and that I would share in the fallout. I'd figure out how to adjust things so that I wouldn't have to foreclose, and the mortgagor would continue to make payments, but whatever - I'd try to settle.

I also try to get to know my local bank personnel. They aren't "the bank," but they might make an effort to help me out if I have a problem. They probably don't have authority to do much for me, but whatever.

So, no, the "fabric of society" is still intact.

[CaseyL]

I think a look at the sheer numbers should be a factor. If a vanishingly small percentage of home loans go underwater, or are defaulted on, then it's a non-systemic issue and the basic morality of a contract isn't affected.

But in this case millions of people lost their homes to foreclosure - to the point that entire communities became ghost towns.

This happened in a market that was already destabilized due to factors the individual borrowers had little to do with (i.e., offloading mortgages the minute they were signed to credit entities created for the singular purposes of bundling and leveraging over and over again, until the final "worth" of the bundled mortgages bore very little resemblance to the actual value of the real estate involved).

Individual borrowers scarcely understood the terms of their own mortgages; no way were they equipped to understand the enormity of bank debt their mortgages "anchored."

This is where what would have been isolated instances of individual failures became a systemic problem - of predatory loans compiled into a parasitic Jupiter of bank debt. And when the music stopped and the there wasn't anyone left to sell those nearly-worthless (in real terms) investment bundles to, the economic structure that supported the whole thing collapsed.

People who might have been able to pay their mortgages lost their jobs - not because of anything they did, but because of everything the banks and Wall Street did. Each collapsed industry that destroyed a large employer had ripple effects wiping out smaller employers, and causing more job losses, and more people stuck with mortgages they couldn't pay.

The distortions are too big. The problem is systemic. It's not a failure of individual morality; it's a failure of a system that was unregulated, unchecked, and non-productive.

I don't see the value of insisting that individuals be the only ones with a moral responsibility when the instruments to which they "owe" that moral responsibility operated with an utter lack of morality - or, indeed, common sense.

[sapient]

I don't see the value of insisting that individuals be the only ones with a moral responsibility when the instruments to which they "owe" that moral responsibility operated with an utter lack of morality - or, indeed, common sense.

I totally agree, but also: Moral responsibility isn't seen in a vacuum. One decision has to be seen in light of the sum total of moral issues that affect a person at a particular time. If my paying off my mortgage is my first priority over seeing to my children's best interests, that is not (to me) a good prioritizing of moral responsibilities. It's ridiculous to attach moral blame to financial decisions without knowing the particular issues involved in the decision. Obviously, people who are habitually irresponsible, lazy, plus dishonest, sexual predators and drug dealers in the bargain - maybe we can judge those people. Maybe. But people who default on debt have a lot of other things going on, and before you say that their decision is "immoral," it's important to look at those things.

[bobbyp]

Absent aggregate real income growth, the inexorable geometric pressure of compound interest would, I should think, eventually rend the social fabric.

[Brett Bellmore]

You can deny that contracts such as mortgages should be seen as morally binding promises, but the fairly large number of people who continue to pay mortgages on homes they've had to move away from demonstrates that quite a lot of people still DO view them as morally binding promises. I assure you that I didn't continue paying on my house in Michigan for two years after I'd had to leave the state out of economic calculation.

I did it because I'd promised to make those payments.

Don't deny that people hold moral convictions just because you don't share them....

[Tony P.]

Don't deny that people hold moral convictions just because you don't share them....

Contracts were invented precisely because everybody does know that people have different "moral convictions". So was democratic government.

Corporations (the counterparties in many contracts, like mortgages) were invented later. They were invented as purely contractual -- not moral -- actors. Even now that corporations have been endowed by their creator with personhood, they are not expected to act morally. They have lawyers, not pastors, on staff.

Like Brett, I have my own sense of morality. And it includes the principle that it's wrong to not pay my debts. Unlike Brett, perhaps, I look at my debts to corporations the way a corporation would: what does the contract actually say I owe?

To be honest, I have not read all the papers that I signed when I bought my house with a mortgage. I merely assume that the contract says I owe the lender either 1)regular monthly payments, or 2)my house. "The" lender, I should add, has changed names 5 times, one of those times involving bankruptcy. I haven't.

It's hard for me to feel the same sense of "moral" obligation to my mortgage lender that I would feel toward Brett, say, if I borrowed money from him.

--TP

[Hartmut]

There are two sayings that were already old when I was born

1. To get credit you have to prove that you don't need it.
2. Owe 100 bucks and the banks owns you, owe a million (add 3-6 zeroes to update) and you own the bank.

The problems really began when those rules ceased to properly dsecribe reality.
Creating a chain going beyond a single creditor-borrower relationship played I think a great role too. Once the creditor borrows the money to lend (from one who also borrowed it from one higher up), the system becomes inherently unstable in the long run.

Although I share the view that it is moral to try to pay your debts, this has become a tool by unscrupulous lenders who consider this as the mark of the sucker/loser. One should get especially suspicious when the contracts explicitly block the option for the borrower to pay off the whole loan in one go before the contract runs out. Should it be also rate adjustable, it should not be signed in the first place.

[bobbyp]

Don't deny that people hold moral convictions just because you don't share them....

Why yes. And if you throw enough stones, you will hit a glass house eventually.

[Countme-In]

This moral posturing is touching in an economic culture that has enshrined "buyer beware" as its motto.

Beware of what?

I don't know, the print is so infinitesimally small that my progressive bifocals fail me.

I do try and read MSN Money's Top Ten Things Your Mortgage Lender Won't Tell You and Top Ten Things Your Plumber Won't Tell You, and Top Ten Things Your Airline Won't Tell You, and Top Ten Things The Officer Who Pulls You Over For A Traffic Infraction Won't Tell You, or Top Ten Things Your Money Manager's Quant Won't Tell Which You Wouldn't Understand Anyway, and Top Ten Things Your Evangelical MegaChurch Pastor Won't Tell You and Top Ten Things Your Sausage Maker Won't Tell You who, By The Way, Heads Up The Local Chapter of Your Libertarian Party.

True, consumer protection and legislated transparency has shed a little light on the top ten when pushed to the wall, but why do I suspect the legal departments of the above sampling are working on some prolix anna canna penna language for Numbers 11 thru 25 of the things you're not going to be told.

It's nice that pharmaceutical ads, in which the positive attributes of the drug being offered are expressed in gauzy images of well-being and possible sexual gratification down the road, are now followed by a fast talker listing the 37 side effects they didn't want to tell you and hope you're too lazy or horrified to think about.

Vomiting AND blindness? Tell you what, let's just TIVO those ads out all together.

George Bernard Shaw wrote that "every profession is a conspiracy against the laity." Ambrose Bierce weighed in recently too.

We transact our business swimming in a lubricating gelatin of little white lies which enables a minimum of friction on the path to money changing hands.

It's an understanding we have with each other, communicated by the occasional wink or maybe a thousand-foot stare.

Yes, it would be nice if we dealt with each other with complete honesty and forthrightness and with a common language not splintered into the specialized grifty jargonese patois ("Now, please turn to page 27, graph 12, clause 12c, I quote, now, in the event of unexpected disintermediation, the applicable coefficient shall ... ") of our respective professions.

If you work for any private or public institution and you project an honest face, that's good .. congratulations. But you've got backup down in legal and accounting and public relations and advertising.

What the f*ck do you think those people do all day?

Sit around advising each other to just tell like it is?

I notice now in recent legislation, as one example, that entrepreneurs (when in doubt, speak French) will now be able to solicit stock offerings and raise money via social media like Facebook, etc, a streamlining measure.

What could go wrong?

Maybe the Mafia and the drug cartels have the right idea. EVERYONE is a liar and a cheat. But, can I trust you to satisfy both of our mutual interests? Your word is your bond that you'll observe the code. But if not, the fishes, they shall swim with you.

Well, probably not. Too messy. Let's be nice, look the other way on a modicum of prevarication and grifting, and call it civilization.

But lawyer up, just in case.

Yeah, I know, it's terrible, but it's the best we have.

[Countme-In]

The Marx Brothers tied up any loose ends Ambrose Bierce left dangling.

http://www.youtube.com/watch?v=B7IoGCdHCMA

[Julian]

"When I got out of college, contracts WERE viewed as morally binding promises, and while they might have had penalty clauses, you were still widely viewed as doing something wrong if you violated them."

What I learned in Contracts was that penalty clauses are not enforceable precisely because they are penalties. When X breaches his contract with Y, Y is legally entitled to damages, but there are no punitive contract damages (unlike tort law).

Note that not all contract provisions that promise some bad consequence to X if X breaches are considered penalties. Still, the point is that a contract is an economic arrangement, and you legally have the option to breach at any time - you're merely choosing to pay damages instead of performing.

This is not to say that you're wrong about how contracts were viewed when you graduated college. But I'm not sure what your point is - are you hearkening back to a more virtuous and innocent time? Were things better then? If so, I submit that it' nots only greedy opportunistic borrowers who are responsible for change in how we view bankruptcy.

[Sebastian]

I think the contract digression is a bit beside the point. The problems with school loans are in these areas:

A) They were made against a college education with spiraling price structures that have been dramatically above costs/inflation for DECADES--and compounding for decades makes for enormous price increases.

B) Unlike traditional markets, where businesses find that if they make the price too high they lose customers, colleges have been able to sustain this because of a confluence of social pressure to go to college and government financial support of loans to pay for it. As I've argued before here it isn't clear that government loans are doing much in the long run other than dramatically run up the price of college.

C) In the case of graduate degrees, we may very well be talking about people who simply cannot realistically repay the loans in question. Until the most recent bankruptcy change, school loans more than 7 years out of college could be discharged in bankruptcy. I'm pretty sure it wouldn't ruin the economic world to go back to that.

[bobbyp]

Seb,

A) College costs have been rising faster than inflation for much of the last century. The core reasons for this may be related to the way the product is delivered (similar to health care...another area subject to increasing costs pressures). Ask the revolutionaries at http://www.forbes.com/2010/08/01/rising-cost-education-opinions-best-colleges-10-feldman-archibald.html> Forbes.
B) Misguided public policies since Reagan have consciously striven to shift income upward. Coupled with the fact that statistically, to go without a college education is to commit economic suicide, it is hardly surprising that demand for the credential has increased.
C) Gutting public contribution and/or subsidy to higher education has led to a greater reliance on loans. This is hardly surprising.

Thus to conclude that student loans are 'running up' the cost of college strikes me as inferring a line of causality that is exactly backwards.

And last, but not least, for Russell http://www.nakedcapitalism.com/2012/03/daniel-alpert-consumer-credit-growing-at-highest-rate-in-past-decade-unhealthy-and-unsustainable.html>this.

[Sebastian]

Bobbyp, I can never really tell when you're just trolling, though I'm suspicious of you citing Forbes. There doesn't seem to be a good reason why the product as delivered should show such an enormous and continual spike in price.

I can't speak to the underlying research, but the article as presented looks crappy.

"For starters, the dysfunction stories have trouble explaining why inflation-adjusted college costs were flat or falling for over a decade in the 1970s and early '80s, or why the rate of cost increases is so high today, but was not nearly as high in the '60s, when baby boomers began flooding into school."

I don't know about the 'dysfunctional' story, but my rent-seeking story fits the timeline quite well.

"Instead of holding up a magnifying glass to the industry, we take an aerial view."

That bit almost directly advertises "we aren't really going to deal with schools directly enough to be useful".

By contrast, labor productivity in basic manufacturing has soared, and this is why the cost of a year of college has gone up compared with the purchase price of a basic car or a basket of groceries.

Students interacting directly with professors and other students in small groups remain a benchmark of quality in education. Ask any family if they want their son or daughter to learn in small group seminars taught by tenured professors, or if they prefer giant impersonal lectures or online chat rooms monitored by adjunct teachers who answer lots of e-mail questions.

Yes Baumol's cost disease exists. I'm a big proponent of being aware of it. However comma, Baumol's disease is entirely a function of labor costs, and I'm absolutely 100% certain that professor's salaries have not been going up at about 2.5 times that of inflation over thirty years. Furthermore, raising the specter of large class sizes *as if keeping them small is driving up price* is almost precious. Note to William and Mary professors, most colleges have all sorts of classes with impersonal lecture halls.

The 'chemistry equipment costs alot' reason isn't compelling without evidence that those expenditures are A) an enormous part of the budget and B) actually going up at the rate we are talking about.

Everything I've seen suggests the money has been spent largely on administration--especially much higher administrative salaries (see for example the salaries of each of the UC campus presidents) or on bigger and often not student related building projects.

So while my theory may not be correct, or may only be a small piece, that article does literally nothing to convince me.

As for your B), I have no idea how you are trying to connect those ideas to the higher price. Also I'm not at all sure that there is any evidence that the demand has outstripped the supply, which has increased enormously. Without the demand drastically exceeding the supply, you can't easily invoke supply/demand issues to explain the skyrocketing price.

As for C) you need to get the timeline straight. The greater reliance on loans PREDATES the very very recent 'gutting public contribution' by about three decades. Following that up with a suggestion that I'm the one inferring a line of causality that is backwards is a gutsy tactic.

[Sebastian]

Also your gutting public contribution supposition tends to ignore that the skyrocketing price has largely been in the PRIVATE institutions, only recently in the public ones.