Walk the Line or Walk Away?

Blogworld’s got an interesting back-and-forth going on about the morality of walking away from a mortgage.

I’ve got to admit, I instinctively sympathize with the Megan McArdle line of thinking—that if you promise to pay for something, and you’re able to pay for it, you oughta pay for it. I think the vast majority of people think the same and will do the same.

But the problem here is the whole “contracts for thee, but not for me” aspect of business. Why is it that the little guy is morally bound to pay his mortgage when the big developer isn’t? McArdle:

Well, for one thing, companies don’t always behave like this, and those who get a reputation for stiffing their suppliers run into trouble.

In commercial real estate, which I used to cover, it would be hard to find a developer or owner who hasn’t handed back the keys to a bank, often serially. Harry Macklowe does it every downturn and still the lenders come back to him. It’s part of the business. They do so, as Steve Randy Waldman of Interfluidity writes in a super-smart piece, because businesses have no social responsibility, at least according to the vastly influential words of Milton Friedman (McArdle disputes this, weakly, in a subsequent post).

That includes the banks themselves, of course. Morgan Stanley handed back the keys on its stupid $6.5 billion purchase of Crescent Properties last month (Morgan Stanley only put a sliver of equity in, so its loss is far below that). It didn’t seem to face much moral outrage from Barclays, its lender.

In fact here’s how the good WSJ piece linked above described Morgan Stanley’s thinking:

Morgan Stanley’s decision to hand over Crescent’s holdings to Barclays “means that the value of the properties is below the debt, and Morgan didn’t think the value would come back up anytime soon,” said Cedrik Lachance, an analyst with Green Street Advisors Inc., a research and trading firm.

That’s what’s happening with homeowners right now. Some of these properties are so underwater, they may not come to the surface in the owner’s lifetime. It’s called business. Let’s not pretend the lender went into this thing eyes wide open.

But that’s not a one-off lapse for MS. It’s downright falling into moral turpitude by the standards of the keep-the-keys crowd. This week, Morgan Stanley walked away from another deal, this one a $2.5 billion San Francisco office portfolio.

Here’s the problem with this line of thinking, according to Felix Salmon who has been on this issue for a good while now:

(It is) a system tilted enormously in favor of institutional lenders who exist in a world of morality-free contracts, and who conspire to lay the world’s largest-ever guilt trip on any borrower who might think about joining them in that world. It’s asymmetrical, it’s unfair, and it’s about time that homeowners started being informed that a ding to their credit score is not the end of the world; that no one would expect a capitalist company to behave in the way that individuals are being told to behave; and that their options are in fact broader than they might believe.

Waldman puts it more succinctly:

But so long as the “social responsibility of business is to increase its profits”, the social responsibility of customers is to look to their own self interest. Even if that means dropping their house keys in the mail and renting the place next door.

Want to argue with that logic?

McArdle raises a serious point when she says society depends on us all to not act like businesspeople:

The reason we can have easy bankruptcy and a pretty robust credit market (usually) is that most people act like debts are obligations which should always be paid off if possible.

But here’s a counterpoint: We all agree banks lent too much, too aggressively over the past five years-plus. A more businesslike environment for homes might encourage lenders to actually underwrite loans from now on. Homeowners getting out from under bubble-era notes will also free up income to be put back into the real economy.

What some ambitious business reporter out there might want to think about is a story looking at the walkaways corporations do, especially ones holding lots of underwater mortgage loans.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.