Should We Care if People Don't Pay Their Debts?

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There has been a meme going around for a while that you don't really have a moral obligation to pay your mortgage, because the contract contains embedded options for the lender: you can pay them back, or they can take the house.  I've long thought that this was rather silly.  Go look at your mortgage documents.  You will notice that the contract does not specify any option for you to give them the house in lieu of payment.  The note you signed includes a promise to pay, period.  It also specifies what will happen in the case of breach, but you have specifically promised to avoid breach at all costs.  


Maybe you think there is no moral obligation to keep your promises.  Try it in the context of your personal life:  it's okay for my boss to stiff me out of that raise they promised, because I can always quit.  It's okay for my wife to cheat on me, because I can always get a divorce.  It's okay for my roommate to neglect to pay her half of the rent on the first of the month, as long as she's willing to move out.  It's perfectly fine for my son to default on that car I cosigned, because the lender has the option to sue me for the balance . . . hey, wait a minute!

Suddenly it turns out that you think promises create a moral obligation--as long as those promises are made to you.

Nonetheless, I see that this idea seems to be spreading outside of the mortgage context.  From the comment thread on my student loan post

GPurcell: It's ridiculous to talk about morals in this context. What's in the contract is all that matters.

texan99: Is there some ambiguity in the contract about whether the loan is supposed to be paid back?

gpurcell: The contract and the law governing the contract contain provisions for non-performance and any risk is priced into the interest (or should be). What I object to is imposing an additional moral obligation on a borrower beyond the terms and conditions of the loan.

This argument makes even less sense outside of the mortgage context.  At least there, people could argue that commercial borrowers do it (sort of, except that non-distressed borrowers don't stop paying their mortgages; they negotiate a giveback of the property.  if they just stopped paying, they'd be in default, with all sorts of repercussions for their other debt.)  They could say that shady lenders had tricked people into awful loans--though there's not much evidence that the strategic defaulters got shady loans, rather than perfectly normal loans for homes that subsequently lost value.  And they could point to the bailouts--they hosed us, so why shouldn't we hose them?  These aren't great arguments, but at least they're arguments.

But what's the moral argument for stiffing your private student loan issuer?  If you think your education was overpriced, or value-less, be mad at your school, not the lender.  Student loans are pretty affordably priced for unsecured personal debt, and since the loans go through college financial aid offices, the lenders aren't particularly abusive.  (Leaving aside the scummier sort of for-profit university, but again, that's mostly a problem with your school, not your bank.)

The answer seems to be "I don't want to pay, and as long as I'm willing to take the hit on my credit score, no one should judge me."  Yet if this were the actual standard by which most Americans lived, would there be any market for unsecured debt?  Or even secured debt for items that depreciate quickly?  Seems unlikely.  In Memphis, Tennessee, where garnishment was very easy, the population was very poor and consequently bankruptcy was very common, the required downpayment on a car used to be . . . the wholesale price of the car (I don't know whether this is still true--the 2005 bankruptcy reform act may have changed things.)

People really underweight the role that norms play in sustaining a modern economy.  I suspect that if the "default option" folks got their way and people started regarding default as a commercial decision with no more moral weight than changing cable vendors, the advocates of this position would be unpleasantly surprised to find that the only thing less fun than being young and burdened with student loans is being young and completely unable to access any form of credit at all.

Update: an interesting exchange between my commenters

Peter Twieg One common variant of this argument that I've run into states that because lenders price default risk into the price of the loan, in the big picture defaulting is simply a fulfilment of their prior expectations and thus not a big deal - your marginal contribution to a higher price is so tiny as to not really be blameworthy at all. Concentrated benefits, diffuse costs.. 
  odinbearded It's funny how close that is to another argument. You know, department stores build a certain loss ratio into their prices so they're not actually losing anything when I take that nice tie.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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