Is it ethical to walk away from a mortgage?

Is it ethical to walk away from an underwater mortgage? The Church of England and its partners in a massive New York City real estate deal gone sour just did. By doing so the church cut its loss to $78 million or 1 percent of it portfolio.

A law professor at the University of Arizona, Brent White, has been getting a lot of press for his provocative stance that homeowners need not feel obliged to continue to pay on an underwater mortgage even they have the means to do so. He says homeowners are suffering under a “norm asymmetry.” If banks and corporation make decisions solely on economic interests, why can’t should homeowners? Homeowners, he says, have been convinced by banks that it’s immoral. White says it’s in the contract — if you walk away, the bank get the house.

The economist Richard Thayer took up White’s argument yesterday in the New York Times

Some homeowners may keep paying because they think it’s immoral to default. This view has been reinforced by government officials like former Treasury Secretary Henry M. Paulson Jr., who while in office said that anyone who walked away from a mortgage would be “simply a speculator — and one who is not honoring his obligation.” (The irony of a former investment banker denouncing speculation seems to have been lost on him.)

But does this really come down to a question of morality?

On NPR’s Talk of the Nation last week White put the answer this way:

Millions of Americans who are underwater would, in fact, be financially better off if they did walk away, just like Morgan Stanley recently walked away from five properties in San Francisco, five buildings which were underwater. Morgan Stanley just gave the properties back to the bank. But most homeowners, or homeowners as a group, don’t walk away. They don’t strategically default.

And they don’t so because of anticipatory shame and guilt and what I believe is an exaggerated fear about the consequences of waking away from a mortgage. And I argue in my paper that these emotions of fear and shame and guilt are cultivated by the government, by the financial industry and, to some extent, the media. And they do this by cultivating a double standard, a standard in which Americans, average Americans are told to have a moral obligation to pay their mortgage and to meet their financial obligations, whereas corporations freely and frequently default when it’s in their financial best interest to do so.

And, in fact, they would be obligated to protect the interest of their shareholders and walk away from an underwater mortgage if it was a financially wise decision. And my argument is that this norm asymmetry, the difference in norms between average Americans and banks leads to distributional inequalities whereby average Americans are bearing a disproportionate burden from the housing collapse.

On Monday, acting in the interests of its shareholders is exactly what the owners of another property did:

Tishman Speyer, the American property group that owns the Peter Cooper Village-Stuyvesant Town development in Manhattan, confirmed yesterday that it was turning over the 11,000-home complex, which was built by Metropolitan Life in the 1940s for returning Second World War veterans, to its creditors.

But, wait, there’s more:

The Church of England has suffered a £40 million loss [65.5 million dollars] on a disastrous investment in a New York apartment complex that was acquired by a consortium in 2006 for $5.4 billion [$4.4 billion of which was borrowed] — the biggest single residential property deal in the United States.

A spokesman for the Church Commissioners said that it had written off the entire value of its investment and added that the commissioners were “looking carefully” at the lessons to be learnt. “The investment was made in June 2007, which, with hindsight, was at the top of the property market and immediately before the credit crunch,” the spokesman said. …

The loss amounts to nearly 1 per cent of the total £4.4 billion assets held by the Church Commissioners to sustain the nationwide ministry of the Church. It follows a 19.6 per cent fall in the value of the commissioners’ investments in 2008 and comes as the Church faces criticism for allowing the build up of a £352 million shortfall in its pension fund, which is invested entirely in equities.

The spokesman for the Church Commissioners said that the episode had taught it that borrowing at such levels could be “destructive”.

Rowan Williams, the Archbishop of Canterbury — and well-known critic of the market economy, excessive borrowing and speculators — is in New York this week. Monday night he received the Campion award for letters from the Jesuits. Today at 9:00 AM he is making the opening address at the Trinity Institute’s conference Building an Ethical Economy: Theology and the Marketplace. Get video and more by following the link.

By the way, the business model for making money on the Stuyvesant property deal?

convert rent-regulated apartments to market-rate rents

More. Some things are a breach of law:

Last fall the state’s highest court ruled that the owners had improperly deregulated and raised rents on about 4,400 of the apartments while getting special tax breaks from the city.

More for U.S. taxpayers:

Also in the mix are the government-controlled mortgage giants Fannie Mae and Freddie Mac, which together hold a bond that is secured by as much as $2 billion of debt on the property.

Addendum. ENS has an excellent report on the default and says the Church of England lost $78 million.

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