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Asymmetrical Norms: When Corporations Battle People

Is it morally acceptable to walk away from your underwater mortgage?

I ask because, as we all know, the economy continues to suck, unemployment remains high, and mortgage lenders continue to refuse to renegotiate with homeowners holding underwater mortgages.  The federal government’s “making home affordable” initiative has failed, and the question is, what should we do about it?  As the NYT reports, the Obama team plans to try something different:

The Obama administration on Monday plans to announce a campaign to pressure mortgage companies to reduce payments for many more troubled homeowners, as evidence mounts that a $75 billion taxpayer-financed effort aimed at stemming foreclosures is foundering.  “The banks are not doing a good enough job,” Michael S. Barr, Treasury’s assistant secretary for financial institutions, said in an interview Friday. “Some of the firms ought to be embarrassed, and they will be.”  [Emphasis mine.]

Count me as a skeptic.  Unlike actual human beings, corporations are notoriously difficult to embarrass — see, e.g., Goldman Sachs.  Corporations aren’t burdened by the same moral considerations that individual people are; they don’t feel shame, embarrassment, or guilt.  In negotiating with individual homeowners, a mortgage lender can use this “asymmetry of norms” to its advantage.  For example, why don’t more homeowners exercise their contractual and legal rights to walk away from their mortgages?

Brent T. White

Brent T. White

In an interesting paper (via LATimes), University of Arizona law professor Brent T. White argues that this imbalance between the norms governing lenders and homeowners unfairly privileges lenders.  Homeowners have the contractual right to walk away from an overly burdensome mortgage in exchange for giving back the house, but few do.  Why?  One reason is that individual borrowers feel guilty or ashamed if they walk away; they think they’re doing something immoral by not paying back their loans.  The lenders aren’t bound by the same emotional and moral considerations.  White claims, plausibly, that lenders use this against homeowners:

Most lenders will, in other words, take full advantage of the asymmetry of norms between lender and homeowner and will use the threat of damaging the borrower’s credit score to bring the homeowner into compliance. Additionally, many lenders will only bargain when the threat of damaging the homeowner’s credit has lost its force and it becomes clear to the lender that foreclosure is imminent absent some accommodation. On a fundamental level, the asymmetry of moral norms for borrowers and market norms for lenders gives lenders an unfair advantage in negotiations related to the enforcement of contractual rights and obligations, including the borrower’s right to exercise the put option. This imbalance is exaggerated by the credit reporting system, which gives lenders the power to threaten borrowers’ human worth and social status by damaging their credit scores – scores that serve as much as grades for moral character as they do for creditworthiness.  The result is a predictable imbalance in which individual homeowners have born a huge and disproportionate burden of the housing collapse.  [p. 40, footnotes omitted.]

The fact that corporate lenders do not negotiate in the same ethical environment as individual borrowers should inform discussions like the one in this blog post.  It also helps to explain why it’s been so difficult to induce lenders to voluntarily renegotiate mortgage terms with borrowers that are underwater.  White gives his own answer to the question of whether or not it’s morally acceptable to walk away from your mortgage:

Regardless of the precise policy prescription, it is time to put to rest the assumption that a borrower who exercises the option to default is somehow immoral or irresponsible.  To the contrary, walking away may be the most financially responsible choice if it allows one to meet one’s unsecured credit obligations or provide for the future economic stability of one’s family.  Individuals should not be artificially discouraged on the basis of “morality” from making financially prudent decisions, particularly when the party on the other side is amorally operating according to market norms and could have acted to protect itself by following prudent underwriting practices.  The current housing bust should be viewed for what it is: a market failure – not a moral failure on the part of American homeowners.  That being the case, it is time to take morals out of the picture and search for an equitable solution to the negative equity problem.  [p. 52.]

I agree with White that if it’s morally OK for banks to exercise their rights under a contract with a borrower, it’s OK for the borrower to do the same.  (This leaves aside the separate question of whether the terms of the contract are themselves morally acceptable.)

White’s paper leads me to wonder about other instances where current law may unfairly favor the corporate party in a contract with an individual because of an asymmetry of norms similar to the one White discusses.  I suspect examples like this are ubiquitous.  One of the silver linings of this economic crisis may be that it helps to discredit economic theories based on the fiction that we are all some sort of fully-rational homo economicus.  Corporations may approach this ideal, but individuals seldom do.  The enterprise of “law and economics” might then, to the extent that it takes the conclusions of behaviorists seriously, begin to argue for laws that recognize the problem of asymmetrical norms.

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