Strategic Default is a Moral Dilemma. That’s simply adorable, don’t you think?

Originally posted in January 2010.

Lately, one report after another is discussing the issue of “strategic defaults,” or as the mortgage banking industry would call them “ruthless defaults”.  These are the foreclosures that happen on purpose.  People find themselves owing significantly more than their property is worth and they decide to walk away from their indebtedness instead of spending the next 20 years paying hundreds of thousands more than the property is worth.  Crazy, huh?  Go figure.

Apparently, there are some people that think such a decision involves some sort of moral dilemma.  Isn’t that just adorable?  A moral dilemma… there’s something immoral about walking away from your mortgage?  Okay, so I have questions.  Is it less or more immoral than say… gay marriage?  Or what about flag burning?  How does walking away from your mortgage compare with flag burning on the morality scale?  If you’re even thinking about trying to answer that question… give it a rest.

I understand why people want to keep their home.  I understand why they don’t want to lose it to foreclosure.  I even understand why some people choose to stay in a home that’s seriously underwater… for a while, anyway.  But, if I were underwater in a property by hundreds of thousands of dollars with no hope of ever having any equity of which to speak, I’d walk away in a New York minute without feeling the least bit immoral for having done so.  It’s a mortgage, for heaven’s sake.  What’s moral or immoral about a mortgage?

When I take out a mortgage I take on a certain amount of risk.  And the investor funding my mortgage takes on a certain amount of risk.  And we both hope the risks we’re taking pan out.  If they don’t, for either party, well… that’s the way the cookie crumbles.  The investor may decide he wants out of the deal for whatever reason and decide to sell the mortgage to another investor.  And I may decide that it’s not working out for me, and if I do… and I can’t sell the property… well, I may walk away.  The investor gets the property and I get the foreclosure on my credit report.  I don’t even see where morality enters into the equation.

Let us say that you owed $600,000 and the house appraised for $400,000.  Here’s how today’s strategic default might work out:

A. You stop paying your mortgage payment, which is $3500 a month, and your property taxes, which are $8,000 a year.  Savings in 12 months: $50,000.

B. One year is how long you can easily stay in the house before they actually kick you out, and you may be able to get 18 or even 24 months, you never know.

C. Keep all other payments current… car loans, credit cards.  You only want to let your mortgage payment lapse, nothing else.  That way all of your other credit lines will remain intact.

D. Go rent a house down the street or wherever you want.  Rents are way down essentially everywhere.

E. Two years later start shopping for another house.  Pay $300,000 for the same house you owed $600,000 on before walking away, and start building equity immediately, because you’ve saved $100,000 to put down over the last three years.  Aren’t you happy now…

These days, it occurs to me, there would be even less morality involved in the decision to walk away from a mortgage.  I can’t believe anyone actually feels morally obligated to a bank today.  Why would anyone possibly feel that way?  About a bank?  You’ve got to be kidding me.

I mean, what type of business would be considered less moral than a bank?  I think I’d feel more morally obligated to a drug king pin than a bank… maybe about the same… hard to say.  It would depend on the dealer, I suppose.

I bank at Citibank and if I ever come out even a nickel ahead in our dealings, I’m having a damn party.  Heck, every time I go into Citi with a friend, we try to carry out the furniture or whatever “art” is hanging on the wall.  The manager hates me.  He chased after me once when I was trying to carry one of the bank’s potted plants to my car.  What’s the big deal?  We, the taxpayers, have given Citi something like $400 million in fabulous cash and prizes for bankrupting themselves.  Why shouldn’t I be able to take home one lousy plant?

Morgan Stanley obviously doesn’t feel morally obligated to the bank that was financing their mortgages, and we’re not talking about a $189,900 three bedroom/2 bath in Palmdale here.  Bloomberg ran the story just two weeks ago under the headline: Morgan Stanley to Give Up 5 San Francisco Towers Bought at Peak.  Here’s how the story starts off… you’re going to love this…

Dec. 17 (Bloomberg) “” Morgan Stanley, the securities firm that spent more than $8 billion on commercial property in 2007, plans to relinquish five San Francisco office buildings to its lender two years after purchasing them from Blackstone Group LP near the top of the market.

 

The bank has been negotiating an “orderly transfer” of the towers since earlier this year, Alyson Barnes, a Morgan Stanley spokeswoman, said yesterday in a telephone interview. AREA Property Partners will take over the buildings. Barnes declined to say when the transfer will occur.

“This isn’t a default or foreclosure situation,” Barnes said. “We are going to give them the properties to get out of the loan obligation.”

Now you see… that’s exactly what I was going to say.  Alyson and I see things exactly the same way.  It’s not a default or foreclosure situation… they’re just giving the bank the properties back in order to get out of the loan.  What’s wrong with that?  There’s nothing immoral about that, right?  Morgan Stanley certainly doesn’t think so, so why would anyone else?  Where this whole moral dilemma thing coming from anyway?

What a crock of crap that is.  What Morgan Stanley is doing is called a “strategic default,” simple as that.  You can dress it up and make it sound like it came directly from the Board of Directors, but at the end of the proverbial day, Morgan wants out because the property is worth half what they paid for it, and they know it will be many years, and probably decades before the price comes back to the previous level.

And guess what… it’s not even the first time Morgan Stanley has walked away this year.  According to the Bloomberg story, this is the second time the mega-bank has defaulted on its obligations… no, that’s the wrong way to say it… it’s the second time the mega-bank has negotiated to surrender property it had previously purchased and was now underwater.  Here’s how Bloomberg described it:

The San Francisco transfer would mark the second real estate deal to unravel this year for Morgan Stanley, which bet big on the property markets as prices were rising. The firm last month agreed to surrender 17 million square feet of office buildings to Barclays Capital after acquiring them for $6.5 billion in 2007 from Crescent Real Estate Equities. U.S. commercial real estate prices have dropped 43 percent from October 2007’s peak, Moody’s Investors Service said last month.

 

“It’s not surprising this deal ran into trouble,” Michael Knott, senior analyst at Green Street Advisors in Newport Beach, California, said in an interview. “It was eye-opening among a group of eye-opening deals. There was almost no price too high in 2007 for office space in top gateway markets.”

 

The Morgan Stanley buildings may have lost as much as 50 percent since the purchase, he estimated.

Morgan Stanley bought 10 San Francisco buildings in the city’s financial district as part of a $2.5 billion purchase from Blackstone Group in May 2007. The buildings were formerly owned by billionaire investor Sam Zell’s Equity Office Properties and acquired by Blackstone in its $39 billion buyout of the real estate firm earlier that year.

 

Well, obviously Mrogan Stanley was under the impression that real estate prices would go up forever.  And it looks like they bit off more than they could chew.  I bet they bought jet skis and Hummers too.  Probably used their office buildings like ATMs… well, maybe not.  They didn’t need to, I suppose.  After all, they turned into a commercial bank over night in order to get TARP funds and countless other taxpayer funded freebies that have allowed the bank to have a record year this year, along with everyone else on Wall Street for that matter.  So, technically they used us as their ATM, but it’s the same idea.

The Bloomberg story doesn’t bother to mention who the bank is that’s eating Morgan’s default… I mean orderly transfer of the property back to the bank that funded their mortgage.  Kind of weird… I mean, they must be very unhappy at having to take a billion dollar loss.

Oh, but wait… they don’t have to take any loss at all, do they?  Thanks to Uncle Timmy, and the myriad of others in the Banker’s Party, the bank doesn’t have to recognize the losses caused by a decline in the underlying value of commercial property at the momeny, so whew… dodged a bullet there, I’d say.  That was close.  Thank God for these new pretending rules, or we might be in serious trouble.  Tim is always thinking, I’ll say that for him.

I like this pretending stuff… it’s cool.  I don’t know why no one has ever thought of it before.  Why did we have that whole dot-com meltdown anyway?  Couldn’t we have just put some pretending rules in place?  If we had, maybe Pets.com would still be delivering 100-pound bags of kibble across the country overnight for free.  It was a great service; you’ve got to admit.  What would you like to bet George W. is watching this and thinking: “Pretending.  Of course, pretending.  Why the heck didn’t we think of that?  Laura, come in here, you’re gonna’ just love this.”

The Agonist, a blog I’ve been reading lately and like a lot, says it so well, it’s just not worth trying to write any better:

The investment banks are winning at this game. Very few mortgages are being renegotiated to allow the homeowners to keep their home, and this despite all the programs of the federal and state governments trying to force renegotiations on to the financial firms. One of the reasons the investment banks are winning is that there is a conscious, deliberate effort by the financial industry, the press, and the government to prevent homeowners from entering into strategic defaults.

 

Americans still view a deliberate default as immoral and a sign of personal failure.

 

Morgan Stanley doesn’t look at it that way, not when it comes to its own behavior. It only expects you, the consumer and homeowner, to have moral attitudes about financial decisions. With the corporations, morality doesn’t enter into it; it’s just business. That is why it is very, very important for strategic defaults by firms like Morgan Stanley to be dressed up as something different ““ as a negotiation done voluntarily for mutual agreement. And after all, Morgan Stanley itself isn’t going bankrupt, just the subsidiary that bought these properties is acting like it’s bankrupt.

 

The last thing the financial industry and our worthy government leaders want is for American consumers to act as irresponsibly and amorally as our corporations do.  If most Americans acted like that, not one major US financial firm would be left standing.

Did everyone catch that last line? If we acted like our corporations, not one major US financial firm would be left standing.  Yeah, well make a mental note of that.  It’s the kind of thing that could come in handy down the road a piece.

Morgan Stanley doesn’t have to walk away from the buildings they purchased during the bubble.  They’re doing great as a result of being loaded with taxpayer funded cash, and not having to recognize losses, but they want out because they’re underwater to such a degree they know it makes no financial sense to continue paying what they’re obligated to pay.  If you or I did that, we be getting foreclosed on, our bank would be calling seven times a day and sending us the nastiest letters on the planet trying to scare us into paying way more than we have to for the property.  But when Morgan Stanley does it, they’re working to negotiate something amicable in order to ensure a smooth transition, or some such nonsense.

Our government seems just hunky dory with the whole deal too.  It’s fine for Morgan to stop paying a mortgage when it’s too far underwater, but not for a homeowner to do the same thing for the same reason?  Well, alrighty then… fair enough.  Whatever they say.

Listen… I can’t tell anyone what to do, nor would I want to, but let’s just make sure we’re all thinking a little more corporately as this battle continues, shall we?  Food for thought… food for thought… I report, you decide… ( walks away whistling…)